What is a fixed annuity?

Annuities are relatively common as part of some long-term retirement portfolio, but can be a bit confusing to understand.

A fixed annuity is like a special savings account offered by insurance companies. After contributions are made to an annuity, it returns a guaranteed interest rate on your money for a specified period of time. As a result, it can provide you with a guaranteed stream of income during retirement. Growth is tax-deferred, so you don’t pay taxes on the money until you begin to take withdrawals.

How does a fixed annuity work?

An annuity is a contract between you and the insurance company. During the accumulation phase, you contribute to the annuity with either a one-time payment or a series of payments over time. The insurance company guarantees to return a specific interest rate, which grows, tax-deferred, in your account.

At a future date, during what’s called the payout or distribution phase, you receive guaranteed payments for a specified amount of time or until your death, depending on the contract provisions.

Types of fixed annuities

There are two types of fixed annuities: deferred and immediate.

Immediate annuities are often chosen by individuals if they are nearing or already in retirement. Soon after making a lump-sum contribution (typically anywhere from 30 days to 12 months), the individual begins to receive distribution payments. Immediate annuities are designed to provide a guaranteed stream of income sooner rather than later.

Deferred annuities typically collect contributions gradually over time and the payout phase does not occur until years or decades later.

Benefits of a Fixed Annuity

When it comes to fixed annuities, there are a variety of benefits that could fit your retirement needs.

Tax deferred growth — Annuities are tax-deferred, meaning you don't pay taxes on any growth until you start receiving payments. For many, this can be an attractive benefit for more potential income growth over the long run.*

Competitive fixed yields — Because fixed annuity rates are set by insurance companies based, in part, on earnings of their own investment portfolios, the rates are often higher than comparable interest-bearing investments, such as certificates of deposit (CDs).

Guaranteed minimum rates — The guaranteed minimum rate of a fixed annuity can help reduce certain risks associated with long-term retirement investments.

Guaranteed income payments — Fixed annuities can provide guaranteed income payments for retirement. Many fixed annuities have flexibility with payouts, as well, with options for a set period of payments to payments that continue for life.

Beneficiary protection — Annuities also provide some protection for your named beneficiary to avoid probate. Depending on the contract, you can either pass on your investment (less any withdrawals) or the contract value should you die before beginning your annuity payout. Death benefits that equal the contract value often come with an additional fee, however.

Fixed Annuities and Retirement

Preserving and accumulating capital to carry into retirement is a major concern for millions of Americans. Given there's always a risk with investments due to the fluctuating market, many have considered fixed annuities as an option to help mitigate volatility.

When looking at your entire financial picture, you — alongside your investment professional — may find that a fixed annuity could potentially help meet your needs or provide a bridge into the next stage of your retirement.

Keep in mind that since annuities are long-term investments, there are typically tax penalties for withdrawals made by anyone under the age of 59½. It's also important to note that withdrawals can reduce your overall future benefit and value; withdrawals are also subject to income tax. Another very important characteristic of annuities that must be regarded when considering withdrawals is the surrender charge period. During this period, which is often the first 3-10 years of a contract, any withdrawals will be subject to a significant charge. Furthermore, if made before the age of 59½, the aforementioned early withdrawal tax penalty would apply. Most fixed annuities do allow for an annual surrender charge-free withdrawal of 10% of the contract value, however.

Who should consider a fixed annuity?

Fixed annuities are designed to provide a guaranteed stream of income for retirement. Because they offer a fixed rate of interest that is not tied to market performance, they may be a good option for individuals who are highly risk averse and want to rely on a guaranteed stream of income in retirement. If having a predictable income is more important to you than higher returns on your money, an annuity may be a good option for you. If you’re worried about outliving your savings, an annuity may also be a good option for you, as certain kinds offer guaranteed income up until your death. Here are some examples of individuals who identified fixed vs variable annuities as a part of their retirement strategy.

Todd is a 49-year-old man who has tucked away savings over the years, but when his wife unexpectedly became ill, he began eating into his savings significantly and is not sure his savings will last for his entire lifetime. He decided to contribute the remainder of his savings to an annuity, which will begin paying out when he is 60, and will provide a guaranteed payout for the remainder of his life.

Mary is a 40 year-old single mom of a special needs child. She knows that her daughter will require care for her entire life. Mary worries about her ability to financially provide for herself and her daughter. She invests in an annuity so that she knows she will have a guaranteed stream of income during her retirement to help pay for her daughter until she passes away, at which time her life insurance coverage will provide funds for her executor to take care of her daughter.

How do fixed annuities differ from other fixed-income investments?

Bonds — When you invest in a bond, you lend money to a government or company for a specified period of time in exchange for interest payments. Bonds are more liquid than annuities, returning principal and interest in a shorter timeframe. In addition, bonds are subject to market fluctuations, whereas the interest paid on a fixed annuity is guaranteed, as the risk of market fluctuation is absorbed by the insurance company. However, annuities generally involve more fees and penalties than bonds.

CDs — Certificates of Deposit (CDs) are offered by banks and insured by the FDIC. Interest earnings on CDs are taxed as interest is earned, so they don’t offer tax-deferred growth as fixed annuities do. Like bonds, CDs offer a return, but not a guaranteed lifetime income stream.

How to choose the right fixed annuity

Even if you have narrowed your choice down to a fixed annuity, there is still additional research to be done in order to select the best annuity for you. It may be helpful to engage a financial professional in this process. Here are some factors to consider when making your decision:

Payout options — Depending on the provisions of the contract, payout may occur for a specified number of years or until your death. Choose a payout option that matches your retirement needs.

Fees — Annuities typically come with a number of fees. It’s important to understand these fees and when they must be paid. Some common expenses associated with fixed annuities include administrative and surrender fees.

Riders — Some annuities may come with an option to purchase riders, which give you the ability to “add on” certain provisions to an annuity. For example, you may be able to add a rider for cost-of-living adjustment, a provision which increases payments over time to account for inflation. Long-term care riders may also be available to help pay for healthcare costs should the need arise. Choosing the right riders can help ensure your annuity meets your particular long-term needs.

Company ratings — You’re depending on the life insurance company issuing the annuity to deliver on their promise to make future payments to you based on your annuity contributions. Take some time to evaluate the company’s ratings and research customer satisfaction ratings before choosing an annuity provider.

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Frequently asked questions about fixed annuities

What is the difference between a fixed and variable annuity?

What does a fixed annuity offer protection against?

What happens to my fixed annuity if I pass away?

Can you cash out a fixed annuity?

Do you pay taxes on annuities?

What should I consider when choosing a fixed annuity?

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