Banking » Investing » Fixed vs Variable Annuity: Which Is Better For You?
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Fixed vs Variable Annuity: Which Is Better For You?

While a fixed annuity provides a guaranteed income stream, a variable annuity invests your money so you may earn more. But, there is a risk.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: April 15, 2024
The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.
Author: Baruch Mann (Silvermann)
Baruch Mann (Silvermann)

Writer, Contributor

Experience

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
Interest Rates Last Update: April 15, 2024

The banking product interest rates, including savings, CDs, and money market, are accurate as of this date.

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Table Of Content

What Is A Fixed Annuity

A fixed annuity provides a guaranteed income stream to the annuitant (the person who purchases the annuity) for a specified period, often for the rest of their life. It is considered a type of retirement or investment product.

Key features of a fixed annuity include:

  • Guaranteed Interest: The insurance company guarantees a fixed interest rate for a specified period of time, which provides stability and predictability in terms of the growth of your annuity's value.
  • Safety: Fixed annuities are considered to be relatively safe investments because they are backed by the financial strength of the insurance company. However, it's important to ensure you choose a reputable and financially stable insurance company.
  • Lack of Market Risk: Unlike variable annuities, where the returns are tied to the performance of underlying investment funds, fixed annuities are not subject to market risks. This can be advantageous for individuals who want to avoid the potential ups and downs of the stock market.

What Is A Variable Annuity

Unlike a fixed annuity, where the interest rate and payments are guaranteed, a variable annuity allows the annuitant to invest their premium payments in a range of investment options, typically mutual funds or similar accounts. The value of the variable annuity fluctuates based on the performance of these underlying investments.

Key features of a variable annuity include:

  • Investment Options: Variable annuities offer the potential for higher returns compared to fixed annuities, as they are directly linked to the performance of the chosen investments. However, this also exposes the annuitant to market risks and potential losses.

  • Customization: Variable annuities allow the annuitant to customize their investment strategy by selecting from a range of investment options. This can be appealing to individuals who want more control over their investment decisions.

  • Potential for higher returns (but there's a risk): With a variable annuity, you have the potential for higher returns than with a fixed annuity. This is because your money is invested in the stock market, which has historically outperformed other asset classes over the long term. However, you also have the risk of losing money if the market performs poorly.
Fixed Annuity
Variable Annuity
Guaranteed Interest
Investment Options
Safety
Customization
Lack of Market Risk
Potential for higher returns (but there's a risk)

Fixed Vs Variable Annuity: Similarities

The mechanic behind both types is the same:

  1. Purchase: The annuitant pays a lump sum or a series of payments to the insurance company. This is called the premium.

  2. Accumulation Phase: During this phase, the premium you've paid accumulates interest at a fixed or variable rate, based on the annuity you selected. The interest earned is tax-deferred, meaning you don't have to pay taxes on it until you start receiving payments.

  3. Distribution Phase: After a certain period of time or at a specific age, the annuitant can start receiving regular payments from the insurance company. This phase is known as the distribution phase or the annuitization phase. The payments can be received monthly, quarterly, annually, or on a schedule that's agreed upon when purchasing the annuity.

Fixed Vs Variable Annuity: Key Differences

Fixed annuities and variable annuities are two distinct types of annuities that offer different features and benefits. Here are the key differences between them:

Feature
Fixed Annuity
Variable Annuity
Rate of return
Guaranteed
Not guaranteed
Risk
Low
High
Flexibility
Limited
High
Fees
Typically lower
Typically higher
  • Interest and Investment Performance: In a fixed annuity, the insurance company guarantees a fixed interest rate for a specified period. In a variable annuity, your premium is invested in a range of underlying investment options, such as mutual funds. There is potential for higher returns, but also increased risk due to market volatility.
  • Risk and Returns: Fixed annuities provide a lower risk investment option compared to variable annuities. Variable annuities offer the potential for higher returns due to their exposure to market performance.
  • Income Predictability: Fixed annuities provide a predictable and steady stream of income during the distribution phase. The income from a variable annuity can vary based on the performance of the underlying investments.
  • Fees and Expenses: Fixed annuities generally have lower fees and expenses compared to variable annuities.
  • Flexibility and Control: Fixed annuities offer limited investment flexibility since the interest rate is predetermined. Variable annuities provide more control over investment choices, allowing you to allocate your funds among various investment options.

When You May Want To Choose A Fixed Annuity

Choosing a fixed annuity can be suitable for individuals who prioritize stability, consistent income, and principal protection. Here are some scenarios where a fixed annuity might be a good choice:

  • You want a guaranteed income stream in retirement:  Fixed annuities offer a guaranteed rate of return, regardless of how the stock market performs. This can provide you with peace of mind in retirement, knowing you will have a steady income stream to support your lifestyle.
  • You are risk-averse: If you are uncomfortable with the risk of losing money, a fixed annuity may be a good option. Fixed annuities offer a low-risk investment that can help you preserve your retirement savings.
  • You need a tax-deferred investment: The earnings on your fixed annuity grow tax-deferred, meaning you don't have to pay taxes until you start withdrawing. This can help you grow your money faster.
  • You want to protect your principal investment: A fixed annuity guarantees your principal investment, even if the market experiences a downturn. This can help protect your retirement savings from market risk.
  • You want it to be simple: Fixed annuities are relatively straightforward compared to variable annuities. A fixed annuity can offer a straightforward solution if you prefer a simple investment vehicle without the complexity of managing investment options.

When You May Want To Choose A Variable Annuity

Choosing a variable annuity can be appropriate for individuals who are comfortable with market fluctuations, seeking potential higher returns, and willing to take on more risk in exchange for the possibility of greater rewards.

Here are some scenarios where a variable annuity might be a suitable choice:

  • You want the potential for higher returns: Variable annuities offer the potential for higher returns than fixed annuities. This is because your money is invested in a variety of subaccounts, which are similar to mutual funds. The value of your variable annuity will fluctuate based on the performance of the subaccounts you choose. 
  • You are willing to take on some risk: If you are comfortable with the risk of losing money, a variable annuity may be a good option for you. Variable annuities offer a higher risk investment that can help you grow your retirement savings faster.
  • You want flexibility: Variable annuities offer more flexibility than fixed annuities. You can choose from a variety of subaccounts to invest your money in, so you can tailor your annuity to your risk tolerance and investment goals. You can also change your investment allocation at any time, without penalty.
  • You want tax deferral: The earnings on your variable annuity grow tax deferred, meaning you don't have to pay taxes on them until you start taking withdrawals. This can help you grow your money faster.

FAQs

Fixed annuities offer guaranteed interest rates, principal protection, and a steady income stream, making them a solid choice for those prioritizing safety and consistency.

Yes, variable annuities offer flexibility to adjust your investment allocations among the available options based on your investment strategy and risk tolerance.

While fixed annuities typically have surrender charges for early withdrawals, some contracts may allow for penalty-free withdrawals under certain circumstances

Fixed annuities do not usually provide direct inflation protection, meaning that the purchasing power of your income might decrease over time due to inflation.

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Picture of Baruch Mann (Silvermann)

Baruch Mann (Silvermann)

Baruch Silvermann is a financial expert, experienced analyst, and founder of The Smart Investor.  Silvermann has contributed to Yahoo Finance and cited as an authoritative source in financial outlets like Forbes, Business Insider, CNBC Select, CNET, Bankrate, Fox Business, The Street, and more.
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