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What Is a Fixed Annuity?

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Updated November 16, 2023

A fixed annuity is a type of contract between an investor and a life insurance company. When you purchase an annuity, the insurance company will give you a fixed rate of return for a set number of years (the contract length) so you can calculate how your money will grow over the length of the annuity. The insurance company will then invest the money in low-risk portfolios, and once you opt into payments upon retirement, you’ll get a guaranteed monthly income for a certain number of years (or, in some cases, for life).

Types of fixed annuities

There are two main types of fixed annuities: immediate and deferred. The type you choose will depend on your age and how soon you need to access the money.

Immediate fixed annuities

The annuity begins payments as soon as the contract begins. This is a good option for an investor who is already at retirement age and wants to be able to access the money right away to help cover living expenses. On the downside, an immediate annuity will have a lower rate of return since the money hasn’t had time to sit and accumulate interest over time.

Deferred fixed annuities

Payments to the annuitant will begin at a later date. An investor can start a deferred annuity at any age—either with one lump sum of cash or by adding to it over time—and let the funds grow tax-deferred until they are ready to retire and start receiving disbursements.

How does a fixed annuity work?

A fixed annuity is a contract between an investor, called the annuitant, and a life insurance insurance company. The investor deposits a lump sum of cash into the annuity, and the insurance company guarantees that the investor will receive a certain amount of money, either as a lump sum or as monthly payments, for an agreed-upon time frame. You can set up a fixed annuity to make payments for a number of years or until you die. Having a guaranteed payment can help you budget more easily in retirement since you’ll know exactly how much the annuity will pay you each month.

How does a fixed annuity compare to other annuities?

Fixed annuities are considered fairly safe investments because they are immune to market losses. On the flip side, they’re likely to have a lower return than a variable or indexed annuity. Learn more about the other two main types of annuities to decide which one best fits your needs.

Variable annuities

A variable annuity invests contributions in stocks and bonds, which makes it more vulnerable to changes in the market. However, a variable annuity has the capability of a much higher return than a fixed annuity, making it an appealing option to investors who understand the stock market.

Indexed annuities

An indexed annuity is similar to a variable annuity in that it invests contributions, but rather than investing in stocks and bonds, it invests in market indexes such as the Dow Jones and the S&P 500. If the indexes go up, your earnings will grow, and if they go down, so too will your earnings.

Fixed income annuity: Pros and cons

Pros:

  • Predictable returns
  • Tax-deferred growth
  • Unlimited contributions
  • Guaranteed income

Cons:

  • Lower returns than other types of annuities
  • Vulnerability to inflation
  • Money is not accessible

Benefits of fixed annuities

Fixed annuities have several benefits for investors who want to build their wealth for retirement. This type of annuity has predictable returns, offers tax-deferred growth, does not have contribution limits, and offers a guaranteed income upon retirement.

Predictable returns

Signing up for a fixed annuity will guarantee you a minimum return for the length of the contract. That makes it easy to predict how your money will grow and how much money you’ll have at retirement. Predictable returns also mean you won’t need to worry about your annuity decreasing in value if the market dips.

Tax-deferred growth

Fixed annuity earnings are not taxed while the funds are locked in during the contract period. This allows them to grow tax-free until the annuitant is ready to opt into payments. If you contribute money to the annuity after it’s already been taxed, you won’t owe any taxes on your disbursements when you retire.

Unlimited contributions

Unlike other types of retirement accounts, such as 401(k)s and IRAs, there are no caps on contributions to an annuity. This makes them ideal for investors who have maxed out their contributions to their other retirement accounts, but still want to build wealth to use once they stop working.

Guaranteed income

Because of their predictable returns, fixed annuities can act as a guaranteed source of retirement income. Since you know exactly how much your payments will be, you can budget more easily for your retirement living expenses. 

Disadvantages of fixed annuities

Although fixed annuities have their share of advantages, they also have some disadvantages that investors will need to keep in mind while deciding if a fixed annuity is for them. The downsides of a fixed annuity include lower returns than other types of annuities, vulnerability to inflation, and funds that are inaccessible for the term of the contract.

Lower returns

Since fixed annuities come with guaranteed returns, they’re not vulnerable to market losses. However, this also means they will not benefit from market gains. Other types of annuities rely on the market to provide returns, which means they could earn more than fixed annuities over time.

Vulnerability to inflation

Inflation rates aren’t always predictable, and if the rate of inflation in a given year is higher than the annuity’s rate of return, the annuity will be unable to keep up with inflation. Since the insurance company sets the rate of return at the beginning of the annuity, it’s possible that the annuity will have a low or negative growth rate during times of high inflation.

Inaccessible funds

When you put money in an annuity, it becomes inaccessible until the contract ends, typically at retirement. If you need to use the money for something else, such as a down payment on a house or to help pay for college expenses for a child, you’ll be faced with a 20% penalty tax imposed by the IRS.

Fees

Fixed annuities come with several potential fees that can eat into your savings. The fees on annuities are higher than with other types of investments. Some of the fees are as follows.

  • Commission. When you open an annuity, you’ll pay a commission on the fund's value. This typically falls within 1% to 10% but is usually lower for fixed annuities than for other types of annuities.
  • Fund management. As the annuity holder, you’ll pay any management fees involved in investing in mutual funds.
  • Penalties. As previously mentioned, you’ll face a penalty of 10% if you want to withdraw funds from an annuity before 59 ½.

Inheritance

What happens to the payments if you die before the annuity term ends? Some annuities will stop altogether, but a beneficiary may continue to receive payments with others. There are four ways to structure an annuity, and each affects how the annuity is handled after the annuitant’s death.

  • Life-only: Payments will only be made during the annuitant's life (or, in the case of a joint annuity, the longest-surviving annuitant’s life).
  • Life with refund: Payments will be made during the annuitant’s life; if they die with money left over from what they initially paid in, the beneficiary will receive the balance.
  • Life with period certain: Payments will be made during the annuitant’s life; however, if they specify a period of time and die before that time is up, the beneficiary will receive the balance.
  • Period certain only: Payments will be made for a specified period; if the annuitant dies before that period expires, the beneficiary will receive the balance. If they outlive the period certain, the payments will end.

If the annuity structure allows beneficiaries and the annuitant has a named beneficiary, they will receive payment in one of three ways:

  • A lump sum of cash
  • In regular installments over five years
  • In regular installments for the beneficiary’s anticipated life expectancy

It’s important to note that annuities are not treated the same as mutual funds regarding inheritance. Your beneficiaries will likely need to pay taxes on gains from the original annuity purchase price. This could be significant; however, there are ways to circumvent these taxes with careful estate planning. Contact an attorney specializing in estate planning to find the best path.

Who should consider fixed annuities?

Fixed annuities are ideal for investors who want to supplement their retirement income but aren’t comfortable with the volatility that comes with investing in the stock market.

More on fixed annuities

Still curious about fixed annuities and whether they’re a good option for your retirement savings? The information in this section can help you decide whether you should consider a fixed annuity or another investment option.

Where are premiums from fixed annuities invested?

When you put money in a fixed annuity, the insurance company will invest the funds into fixed-income portfolios, which offer returns without the risk of investing in stocks and bonds. This allows the insurance companies to offer a fixed return to the annuitant, who can then count on a fixed amount of income upon retirement.

How safe are fixed annuities?

Fixed annuities are considered the safest type of annuity because they have a guaranteed rate of return. Other types of annuities make their returns by investing contributions in stocks, bonds, or mutual funds, which can make them more vulnerable to market losses. 

How are fixed annuities taxed?

Fixed annuities are subject to regular income tax upon disbursement. This is similar to how traditional IRAs and 401(k)s are taxed. The main difference is that you’ve already paid taxes on annuity contributions, whereas traditional IRA and 401(k) contributions are taken pre-tax. The tax advantage of an annuity is that, like IRAs and 401(k)s, the earnings on your annuity are tax-deferred until withdrawal. This makes an annuity another way to shelter investment income for potentially many years and there’s no limit on how much you can invest this way.

Who regulates fixed annuities?

Individual states regulate fixed annuities; the federal government does not have a hand in regulating this type of investment. All 50 states insure annuities through guaranty organizations. While it depends on the type of annuity and the state, these organizations insure these investments up to at least $250,000. 

TIME Stamp: A fixed annuity is a low-risk investment that can set you up for retirement.

A fixed annuity can be a good option if you want to maximize your retirement income beyond what your 401(k) or IRA can offer. Fixed annuities offer guaranteed returns and income at retirement, which makes it easier to come up with a budget once you stop working. Although a fixed annuity isn’t the only type of annuity available, it’s the safest when compared to variable or indexed annuities, which are vulnerable to market losses as well as gains and offer a less predictable return.

Frequently asked questions (FAQs)

What are fixed annuities paying now?

Fixed annuities have varying rates depending on the annuity length (the period when the insurer will pay a predetermined interest rate on the funds). Generally, the longer the annuity, the higher the rate. Annuities.org lists the best rates on fixed annuities, which are as follows:

  • Two-year annuity: 5.65%
  • Three-year annuity: 6.25%
  • Five-year annuity: 6.4%
  • Seven-year annuity: 6.3%
  • 10-year annuity: 6.05%

Interest rates are currently higher than in recent years, making it a good time to invest in annuities. When starting an annuity, shop with various providers to choose the one that offers the best rates for the time you want to invest your money.

Who sells fixed annuities?

Annuities are issued by life insurance companies traditionally, but you can buy them through banks, financial planners, and insurance companies.

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