A fixed annuity is a contract that pays a fixed, stated rate of return similar to bank issued CDs. An insurance company issuing a fixed annuity guarantees the interest rate for a certain period of time, such as a year, and then adjusts the rate based on current market conditions. The rate is then locked in for another predetermined period of time.
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A fixed annuity guarantees a minimum rate of return so the annuity owner knows their money will grow no matter how low interest rates fall. While money is in a fixed annuity the growth is tax-deferred. This means the annuity owner will not pay any taxes on the growth of the annuity until a withdrawal is made. Because taxes are not being paid on the growth, money accumulates faster.
Fixed annuities are low risk offering more liquidity than CDs, and typically offer higher yields than bonds, CDs, treasuries, or money market accounts. Typically, a lump sum contribution to a fixed annuity will guarantee an interest rate ranging from 3% – 10% for a period of 1 to 15 years. The minimum contribution (also referred to as a premium payment) to a fixed annuity is typically $5,000.
If you purchase a fixed annuity and pass away while it is in force, and you have named a beneficiary (such as your spouse or child), the full value of your fixed annuity will pass to your heirs without the cost and delay of probate. If you’ve already annuitized your contract for a guaranteed income stream, the income option you chose will determine how much money will to your beneficiaries.
Who Can Benefit Most from a Fixed Annuity?
Fixed annuities are a good choice for retirees or those concerned with stock market volatility. Fixed annuity guaranteed rates often outperform many other investment vehicles. Fixed annuities are ideal for people who:
- Are looking for tax-deferred growth
- Want a fixed rate of return so they know exactly what their money is earning
- Want minimum guarantees not available in other financial vehicles
To know if a fixed annuity is right for you, you need to consider your individual circumstances.
Fixed Annuity Premium Payments
Fixed annuity owners typically have two options when making premium payments to a fixed annuity – single premiums or installment premiums. With a single premium fixed annuity contract, the annuity owner is expected to pay the annuity company one premium or a lump sum. Installment premiums are loosely defined as a specific series of payments that are based on a predetermined schedule or more than one contribution.
Types of Fixed Annuities
There are three types of fixed annuities:
- Fixed Immediate Annuities
- Fixed Deferred Annuities
- CD-Type Annuities
Types of fixed annuities vary based on how benefits or payments are received from an annuity. With an immediate annuity payments begin shortly after the premium payment is made. With a deferred annuity the income stream is received after a specified period of time.
Immediate annuities are used when the annuity owner is looking to receive a continued source of income immediately. An immediate annuity is usually purchased by an individual looking for a guaranteed source of retirement income.
Deferred annuities are used if an individual is interested in accumulating money in a low risk, tax-deferred environment. A fixed deferred annuity allows an annuity owner to defer payment of income tax until the income is needed in the future.
CD-Type annuities are used if an individual wants a guaranteed rate return for the full term of the annuity. Like fixed deferred annuities the annuity owner is able to defer payment of income tax.
Fixed Annuity Payout Options
Fixed annuity payout options are typically received on a monthly basis. However, it is possible to receive income payouts of varying frequencies (such as quarterly, semi-annually, or annually). The annuity income received will depend on factors such as age, gender, annuity features, and annuity values. Generally, there are seven types of fixed annuity income payout options:
- Lump Sum: Allows the annuity owner to cash out their variable annuity and take the entire value as a lump sum. This could potentially have the greatest income tax consequence.
- Systematic Withdrawal: Provides annuity income based on a specific dollar amount and payment frequency. This income payout option allows the annuity owner to maintain full access and control over the remaining variable annuity account.
- Life Annuity: Provides annuity income for the life of the annuitant. Payments are no longer received after the annuitant passes away.
- Period Certain Annuity: Provides annuity income for a predetermined period of time (such as 10 or 20 years) or term. If the annuitant passes away before the term is over payments will continue to the designated beneficiary for the remainder of the chosen period.
- Life With Period Certain Annuity: Provides annuity income as long as the annuitant is alive. If the annuitant passes away before the “period certain” or term, then the designated beneficiary will receive payments for the remaining term.
- Joint and Survivor Life Annuity: Provides annuity income as long as either person named in the annuity is living. Payments are no long made after the second annuitant passes away.
- Joint and Survivor Life With Period Certain Annuity: Provides annuity income as long as both annuitants are alive. If both annuitants pass away before the “period certain” or term, then the designated beneficiary will receive payment for the remaining term.
Fixed Annuity Things to Consider
A fixed annuity can be an important component of your financial and retirement planning, but it is important to make sure it is appropriate for you. Most problems associated with any investment are easily avoidable with the right information. The following is a list of items to consider before purchasing a fixed annuity:
- Don’t Purchase a Fixed Annuity with Money You Need Today: Surrendering a fixed annuity prior to its maturity will trigger surrender charges and penalties.
- Investing Too Young: Withdrawals from a fixed annuity done prior to age 59 ½ will result in a 10% penalty in addition to any ordinary income taxes owed on the gain.
- Make Sure You Know How the Guarantees Work: Most fixed annuities have two guarantees – a minimum interest rate guarantee and the current guaranteed interest rate.
- Surrender Charges: Surrendering or doing a 1035 exchange to another annuity will trigger fees and penalties.
Fixed Annuity Summary
A fixed annuity can be a very useful financial planning tool, specifically in retirement planning. Fixed annuities can help you reach your retirement planning goals with the choice, control, and flexibility they offer. Individual’s interest in a steady and guaranteed income will find fixed annuities to be particularly effective. Fixed annuities are not for everyone, and should only be utilized after careful consideration.
