What is a fixed annuity?
A fixed annuity is a type of insurance contract that promises to pay the buyer a specific guaranteed interest rate on their contributions to the account. On the other hand, a variable annuity pays interest which can fluctuate depending on the performance of an investment portfolio chosen by the account holder. Fixed annuities are often used in retirement planning.
Key points to remember
- Fixed annuities are insurance contracts that pay a guaranteed interest rate on the account holder’s contributions.
- Variable annuities, on the other hand, pay a rate that varies depending on the performance of an investment portfolio chosen by the account holder.
- Gains from a fixed annuity are tax-deferred until the owner begins to receive annuity income.
How a fixed annuity works
Investors can buy a fixed annuity with a lump sum of money or a series of payments over time. The insurance company, in turn, guarantees that the account will earn a certain interest rate. This is called the accumulation phase.
When the owner or annuitant of the annuity chooses to start receiving regular income from the annuity, the insurance company calculates these payments based on the amount of money in the account, the age of the owner, the duration payments and other factors. This begins the payment phase. The payment phase can continue for a specified number of years or for the rest of the owner’s life.
During the accumulation phase, the account grows with tax deferral. When the owner begins to receive income, this money is taxed at their normal tax rate. Annuity owners may also be allowed to make a limited number of withdrawals from the account before the payment phase begins.
Advantages of a fixed annuity
Predictable return on investment
Fixed annuity rates are derived from the return that the life insurance company generates from its investment portfolio, which is invested primarily in high quality corporate and government bonds. The insurance company is then responsible for paying the rate it promised in the annuity contract. This contrasts with variable annuities, where the annuity owner chooses the underlying investments and therefore assumes a large part of the investment risk.
Guaranteed minimum rate
Once the initial contract warranty period has expired, the insurer can adjust the rate based on a specified formula or the return it earns on its investment portfolio. As a safeguard against falling interest rates, fixed annuity contracts generally include a minimum rate guarantee.
Because a fixed annuity is a tax-eligible vehicle, its income increases and its compound tax is deferred; annuity owners are only taxed when they withdraw money from the account, either by occasional withdrawals or as regular income. This tax deferral can make a significant difference in how the account is built over time, especially for people in the higher tax brackets, and the same goes for qualified retirement accounts, such as IRAs and 401 (k) plans, which also raise taxes. deferred.
Guaranteed income payments
Fixed annuities can be converted into immediate annuities at any time chosen by the owner. The annuity will then generate a guaranteed income payment for a specified period of time or for the life of the annuitant.
Director’s relative security
The life insurance company is responsible for the security of the money invested in the annuity and for keeping all the promises made in the contract. Annuities are not insured by the federal government like, for example, most bank accounts. For this reason, buyers should only consider doing business with life insurance companies that obtain high ratings for financial strength from major independent rating agencies.
Annuities often have high fees, so it pays to shop around and consider other types of investments.
Reviews of fixed annuities
Annuities, whether fixed or variable, are relatively illiquid, making them unsuitable for the money an investor might need in the event of a sudden financial emergency. Fixed annuities generally allow one withdrawal per year, up to 10% of the account value.
During the annuity buy-back period, which can last up to 15 years from the start of the contract, withdrawals greater than 10% are subject to buy-back fees imposed by the insurer. Annuity owners under the age of 59 and a half may also have to pay a 10% tax penalty, in addition to regular income taxes.
Finally, annuities often have high fees compared to other types of investments. Anyone interested in an annuity must make sure they understand all the costs involved before committing to it. It is also beneficial to shop around, as fees and other conditions can vary considerably from one insurer to another.