Fixed Annuities (FAs)

Fixed Annuity Highlights

A fixed annuity is a contract between you and the insurance company in which the insurance company allows accumulation of your investment tax-deferred. You make a lump sum deposit, and the insurance company credits your annuity account with a guaranteed fixed interest rate but without putting the principal at risk. A fixed annuity may be annuitized so that it provides a guaranteed income stream to the investor, either for life or for a specified duration of time.

Fixed annuities are popular with investors who’re looking to tap into a guaranteed rate of returns without putting their principal at risk.

How fixed annuities work

Just like Savings Bonds, fixed annuities do provide a safe money feature called a guaranteed minimum return. Unlike Savings Bonds though, you don’t have to wait 2 decades for this guarantee to kick in. Once the investor deposits a lump sum principal, the insurance company promises the investor’s annuity account with a specified interest rate over a number of years.

When you deposit your cash in a bank, they invest this money and earn a return. After taking deducting their costs, they are able to pay interest on your deposit for a period of time. A fixed annuity works the same way, only that you’re depositing your money with an insurance company rather than a bank.

Fixed annuities may be immediate or deferred. Immediate annuities pay out fixed payments, while deferred annuities accumulate over time.

Fixed annuity features

  • Fixed Annuities Competitive Fixed Yields– the return rates of a fixed annuity are derived from the returns a life insurance company earns from its investment. Primarily, these companies will invest their money in top-quality corporate or government bonds. Yields on fixed annuities are typically higher compared to yields of similar, low-risk investments. The yield on your investment is guaranteed for a period of time (e.g. 10 years).
  • Fixed Annuity Guaranteed Minimum Rates – once the guarantee period ends, the yield rate might be adjusted based on a formula that’s determined by the insurance company. As a measure to protect against decreasing interest rates, most (if not all) fixed annuities do include a guaranteed minimum rate.
  • Tax-Deferred Growth – fixed annuities are a tax-qualified investment vehicle offering tax-deferred accumulation of earnings. When the earnings or gains from the investment are withdrawn, they will be taxed like ordinary income.
  • Withdrawals – most fixed annuities do allow a single withdrawal of up to 10% (could be more or less) of your contract value annually. During the surrender charge period, any withdrawal above this threshold (10%) is charged a surrender fee. The surrender charge/fee decrease year in year out till it hits zero at the end of the surrender duration, starting which time withdrawals can be taken penalty-free. In addition to regular income taxes, tax law states that withdrawals taken before the age of 59 ½ years may be subjected to a 10% federal penalty.
  • Guaranteed Income Payments – FAs can be converted to immediate annuities anytime to provide guaranteed income payout for a set duration of time, or though the lifetime of the annuitant.
  • Safety of Principal – capital invested in a fixed annuity is guaranteed by the strength of the insurance company. For that reason, it’s important that you only invest in a life insurance company that has a top-rated financial strength.
  • Death Benefit – in the event of the annuity holder’s death, most fixed annuities pay a death benefit to elected beneficiaries without any withdrawal charges.

Advantages of fixed annuities

Since a fixed annuity contracts pay a guaranteed interest rate, they tend to be more popular amongst investors who are warry of the ups and downs of stock markets. Simplicity, low investment minimums ($1,000-$10,000), and tax-deferral also makes fixed annuities advantageous.

Disadvantages of fixed annuities

Fixed annuities rates might be fixed for a specified duration of time, then drop dramatically after let’s say the first few years. If you want to withdraw your investment during this time, your withdrawals will be subjected to hefty surrender charges.

Is an FA the right choice for me?

If all you want to do is make sure that your money will come in handy during retirement, a fixed annuity is the right choice for you. If you are worried about coming short and do not want to take the risk associated with the stock markets, fixed annuities are worth the consideration.

It’s always advisable to review your situation with a financial advisor to see whether a fixed annuity is the right fit for you. Explore how an FA can play out into your financial plan depending on your risk tolerance and goals. Make sure that you can clearly understand the fees involved and how they work.

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