A fixed annuity is a contract between you and an insurance company, where the insurer guarantees a specific interest rate on your payouts. In contrast, a variable annuity’s rate can fluctuate because it’s tied to the stock market. Fixed annuities are a common part of retirement planning.
- Written by Rachel Christian
Financial Writer and Certified Educator in Personal Finance
Rachel Christian is a writer and researcher for RetireGuide. She covers annuities, Medicare, life insurance and other important retirement topics. Rachel is a member of the Association for Financial Counseling & Planning Education.Read More
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Toby Walters, CFA®
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- Published: May 21, 2020
- Updated: June 24, 2023
- 5 min read time
- This page features 4 Cited Research Articles
- Edited By
Basics of Fixed Annuities
A fixed annuity is a straightforward, low-risk way to help guarantee income in retirement.
Unlike variable annuities, fixed annuities offer predictable, set payouts with lower fees.
Variable annuities, in contrast, carry a higher risk because returns are tied to the performance of underlying investments.
Similarly, indexed annuities are linked to the performance of an index, such as the S&P 500.
- Immediate fixed annuities begin paying out within a year of signing your contract.
- Deferred annuity payments may begin years in the future, such as during retirement.
How Does a Fixed Annuity Work?
You can purchase a fixed annuity from an insurance company with either a single lump sum or a series of payments.
In return, the insurer guarantees that your deposit will earn a fixed annuity rate.
According to the Financial Industry Regulatory Authority, interest rates are often fixed for a certain number of years and then change periodically based on current rates. Your contract will specify these details.
A fixed annuity guaranteed minimum interest rate is usually between 1 percent and 2 percent.
The best fixed annuity rates are above 2 percent. Insurance companies may pay a higher interest rate than the guaranteed interest rate.
Annuities are a popular retirement savings vehicle because money inside the account grows tax-deferred during a period known as the accumulation phase. Annuities enjoy similar tax treatment as traditional 401(k) plans or IRAs.
When your annuity payouts begin, the money you receive is taxed at your regular income tax rate.
Annuity contracts are customizable. Payouts from your fixed annuity can be guaranteed for the rest of your life or for a specific number of years.
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Benefits of a Fixed Annuity
Every investment comes with benefits and disadvantages. It’s important to understand both.
Weigh the pros and cons of fixed annuities before making a decision.
- Predictable Returns
- Experts consider fixed annuities to be the simplest annuity type. Unlike variable and indexed annuities, returns aren’t tied to the performance of underlying stock market investments. All the details are spelled out in your contract, so you know what to expect.
- Lower Risk
- No investment is 100 percent risk-free. But fixed annuities do offer greater peace of mind than other options. Your money isn’t dependent on the performance of stocks or other investments. You are shielded from market crashes and other instability. This is especially important during retirement when most people can’t afford to take major risks.
- Tax-Deferred Growth
- All annuity earnings grow and compound on a tax-deferred basis. You will only be taxed when you withdraw money from the account or begin receiving regular payouts. These are the same tax perks enjoyed by other retirement savings vehicles, such as traditional IRAs.
- Guaranteed Income Payments
- The insurance company is required to honor any guarantees or promises outlined in your contract. If you sign up for lifetime payments, the insurer must deliver.
Disadvantages of a Fixed Annuity
Fixed annuities offer attractive perks, but they aren’t perfect for everyone.
For example, annuities are considered illiquid, which makes it difficult to tap into your money quickly in an emergency without facing significant fees and penalties.
It’s also difficult to withdraw all your money if you change your mind after signing the contract.
Fixed annuities earn relatively low returns. Some fixed annuity rates are comparable with a certificate of deposit, or CD, purchased from a bank or credit union.
Because growth is fixed at a low rate, your earnings may not keep up with inflation.
- Withdrawing more than 10 percent of your account during the accumulation phase may result in surrender charges.
- Withdrawing any money before the age of 59.5 may result in a 10 percent IRS penalty.
- Your annuity guarantee is only as strong as the insurance company that issues it. These products are not backed by a bank, so if the insurer goes belly up, your annuity is at risk.
- No cost of living adjustments to hedge against inflation unless purchased with a rider.
- Relatively low growth potential compared to other investment options.
4 Cited Research Articles
- Texas Department of Insurance. (2020, March 4). Understanding Annuities. Retrieved from https://www.tdi.texas.gov/pubs/consumer/cb078.html
- National Association of Insurance Commissioners. (2019). 10 Things You Should Know About Buying Fixed Deferred Annuities. Retrieved from https://www.insureuonline.org/consumer_life_fda_ten_tips.htm
- Financial Industry Regulatory Authority. (n.d.). Fixed Annuities. Retrieved from https://www.finra.org/investors/investing/investment-products/annuities
- U.S. Securities and Exchange Commission. (n.d). Annuities. Retrieved from https://www.investor.gov/introduction-investing/investing-basics/investment-products/insurance-products/annuities
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