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What Is A Fixed Annuity?

Fixed Annuity guarantees a fixed interest rate on your investment, offers a tax deferred growth and a variety of payout options
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 works similarly to how a regular annuity works – it's a straightforward and secure savings tool that allows you to invest a certain amount of money for a specified period. During this time, the insurance company guarantees a fixed interest rate on your investment.

Unlike other investment options, the value of a fixed annuity is protected from market fluctuations. This means that no matter how the economy performs, your investment will continue to grow at the agreed-upon fixed rate.

Once the annuity's term is over or at a chosen time, you can start receiving payments from the insurance company. These payments can be made in the form of a lump sum or as a series of regular income payments, depending on your preference.

How Does Fixed Annuity Work? Example

Let's illustrate how a fixed annuity works with a simple example:

Let's say you're 65 years old and you want to buy a fixed annuity to provide you with a steady income stream in retirement.

You've managed to save up $100,000 that you want to invest in a fixed annuity. You approach an insurance company, and they offer you a fixed annuity plan with a 5-year term and a guaranteed interest rate of 5% per year.

You decide to buy a 5-year fixed annuity with a guaranteed interest rate of 5%. You invest $100,000 in the annuity, and the insurance company guarantees that your money will grow at a rate of 5% per year for the next 5 years.

During the 5-year term, your investment grows at the fixed rate of 5% annually. Here's how it would look year by year:

  • Year 1: $100,000 + (5% of $100,000) = $105,000 
  • Year 2: $105,000 + (5% of $105,000) = $105,000 + $5,250 = $110,250
  • ……..

After the 5-year term is over, your fixed annuity has grown to $127,628. This amount is guaranteed and not subject to any market fluctuations during the term.

You can then start taking withdrawals from the annuity. You can choose to receive a fixed income stream for a set period of time, such as 10 years, or for life. If you choose to receive a fixed income stream for life, the insurance company will guarantee that you will receive a certain amount of money each month for the rest of your life.

In this example, let's say you choose to receive a fixed income stream for 10 years. The insurance company will pay you $1,063 per month (pre tax) for the next 10 years. This will provide you with a steady source of income in retirement, regardless of what happens in the stock market.

Keep in mind – you may have to pay taxes on your earnings in a fixed annuity. The specific tax treatment of your annuity will depend on your individual circumstances.

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Pros And Cons Of Fixed Annuity

Fixed annuities come with their own set of advantages and disadvantages. Let's take a look at the pros and cons of fixed annuities:

Benefits
Drawbacks
Guaranteed Income
Lower Potential Returns
Tax Deferred Growth
Surrender Charges
Flexible Payout Options
Limited Flexibility
Protection From Market Volatility
Risk Of Insurance Company Default

Fixed annuities offer a guaranteed income stream, which can be a valuable asset in retirement. 

This can provide peace of mind knowing that you will have a steady stream of income, regardless of what happens in the stock market.

Your earnings in a fixed annuity grow tax deferred, meaning you won't pay taxes on them until you start taking withdrawals. This can help your money grow faster over time.

Fixed annuities offer a variety of payout options, so you can choose the option that best meets your needs. 

For example, you can choose to receive a fixed income stream for a set period of time or for life.

Fixed annuities are not subject to market volatility, which means that your money is protected from the ups and downs of the stock market. 

This can be a valuable asset for people who are nearing retirement and are looking for a safe investment.

Fixed annuities typically offer lower potential returns than other types of investments, such as stocks and mutual funds. 

This is because the insurance company is guaranteeing your interest rate, so they need to take on less risk.

If you withdraw your money from a fixed annuity early, you may have to pay surrender charges. 

These charges can be steep, so it's important to read the fine print before you buy an annuity.

Fixed annuities are not as flexible as other types of investments. Once you buy a fixed annuity, you can't change the terms of the contract. 

This means that you're locked in to the interest rate and the income stream that you choose.

Fixed annuities are not FDIC insured. This means that if the insurance company goes bankrupt, you may not get all of your money back.

Fees And Charges Associated With A Fixed Annuity

There are several fees and charges associated with fixed annuities, including:

  • Sales commissions: The insurance company will typically pay a commission to the salesperson who sells you the annuity. This commission can range from 1% to 5% of the amount you invest.
  • Mortality and expense risk charges: These charges are designed to cover the insurance company's costs of providing the annuity, such as the cost of paying out death benefits and administrative expenses. These charges can range from 0.5% to 2% of the value of your annuity.
  • Surrender charges: If you withdraw your money from a fixed annuity early, you may have to pay surrender charges. These charges are typically highest in the first few years of the annuity and then decline over time.
  • Annual fees: Most fixed annuities have annual fees, which are used to cover the cost of maintaining the annuity. These fees can range from $25 to $50 per year.

Fixed vs Other Types Of Annuities

Fixed annuities offer a conservative and secure option with guaranteed returns but limited growth potential. On the other hand, variable and indexed annuities provide more potential for higher returns but come with higher risks. It's a good idea to compare fixed vs. variable annuity benefits and risks before deciding.

Immediate annuities are suitable for those needing immediate income, while deferred annuities offer flexibility and tax-deferred growth during the accumulation phase. The right choice depends on your risk tolerance, financial goals, and retirement needs.

Here's a short comparison between types of annuities:

Type of Annuity
How it Works
Fixed Annuity
Guarantee you a fixed interest rate for a set period of time
Variable Annuity
Invest your money in a variety of mutual funds. The value will go up and down with the stock market
Indexed Annuity
Invest your money in a stock index, such as the S&P 500. The value will go up and down with the stock market
Immediate Annuity
You pay a lump sum of money and start getting an income stream immediately
Deferred Annuity
start getting an income stream at a later date, such as when you retire

How To Choose A Fixed Annuity?

Choosing a fixed annuity requires careful consideration and evaluation of your financial goals and needs. Here are some steps to help you make an informed decision:

  • Understand Your Goals: Determine why you want a fixed annuity. Are you seeking a stable income stream in retirement, tax-deferred growth, or a safe place to preserve your money? Knowing your objectives will guide your choices.

  • Research Different Providers: Look for reputable insurance companies with a strong financial track record. Check their credit ratings and customer reviews to ensure they are trustworthy and financially stable.

  • Compare Interest Rates: Different insurance companies offer varying interest rates on fixed annuities. Compare rates to find the most competitive one for your investment.

  • Review Contract Terms: Carefully read the annuity contract to understand all the terms, fees, and charges associated with the product. Look for any surrender charges, administrative fees, or other costs that may impact your investment.

  • Check Payout Options: Consider how you want to receive payments – as a lump sum, regular income, or a combination of both. Choose the option that aligns with your retirement and income needs.

  • Assess Inflation Protection: Fixed annuities don't offer protection against inflation. If inflation is a concern, consider other investment options like inflation-indexed annuities or a mix of investments.

  • Consider the Tax Implications: Understand the tax treatment of annuity withdrawals and how it will affect your overall tax situation.

Fixed Annuities vs 401(K) vs IRA

If you're looking for a guaranteed income stream in retirement and you're willing to sacrifice some potential returns, a fixed annuity may be a good option for you. However, if you're looking for the potential for higher returns and you're willing to take on some risk, a 401(k) or IRA may be a better option.

Here is a table comparing fixed annuities to other retirement savings options like 401(k)s or IRAs:

Feature
Fixed Annuity
401(k)
IRA
Guaranteed income
Yes
No
No
Tax deferred growth
Yes
Yes
Yes
Flexible payout options
Yes
Yes
Yes
Protection from market volatility
Yes
No
No
Potential returns
Lower
Higher
Higher
Risk of insurance company default
Yes
No
No

As you can see, fixed annuities offer some unique features that other retirement savings options don't, such as guaranteed income and protection from market volatility. However, fixed annuities also have some drawbacks, such as lower potential returns and surrender charges.

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FAQs

Earnings within a fixed annuity are tax-deferred, meaning you won't pay taxes until you start withdrawing the funds. Withdrawals are typically taxed as ordinary income.

Fixed annuities can have different terms, commonly ranging from 3 to 10 years or more, depending on the specific contract you choose.

No, with fixed annuities, your principal and the interest earned at the guaranteed rate are secure, and you won't experience losses due to market downturns.

Yes, you can use funds from your retirement accounts to purchase a fixed annuity, which can provide tax-deferred growth within the annuity.

The insurance company determines the interest rate based on prevailing market conditions and its own financial strategies. It may also vary based on the annuity term and initial investment.

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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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