Fixed annuities: Definitions, comparisons, pros & cons

For many people, an annuity is a crucial component of a well-rounded retirement planning strategy. It can provide an income stream that begins when you choose, and you can elect to have it continue for a set period of time or throughout your lifetime. Several types of annuities are available, and choosing the right type depends on your needs.

If predictable returns—and income in retirement—are among your priorities, fixed annuities may be a good choice for you.

A fixed annuity is an investment that offers predictable interest and a guaranteed stream of annuity payouts (if you elect to receive them). It's like a safety net for your future.

You can fund a fixed annuity with a single lump-sum payment upfront or a series of premium payments. Then, the annuity is guaranteed to grow at a set interest rate over a specified period of time.

Unlike variable annuities, which are subject to the ups and downs of the investment options you choose, fixed annuities provide predictability. The interest is guaranteed by the claims-paying ability of the insurance company that issued your annuity.

Because your interest rate is fixed, you also know how much interest your annuity will earn. This makes them a powerful tool for planning your retirement income.

When you purchase the annuity, you choose whether you want to start guaranteed annuity payouts within a year of funding your annuity or after a longer accumulation period. At the point in time identified in your contract, you can begin taking withdrawals or—if you elected to annuitize—begin receiving guaranteed annuity payouts that can continue for a set period, for as long as you live or throughout both your and your spouse's lifetimes.

People at all stages of the retirement planning process buy fixed annuities to guarantee interest earnings and a future income stream.

Say you're around 50 and want to allocate some money to secure an income stream in retirement. You could fund a fixed annuity with a rollover from a qualified account or with cash—in a lump sum or a series of recurring payments. Then, when you reach a certain age (65, for example), you may choose to start receiving annuity payouts that could be guaranteed to last for the rest of your life.

The size of a fixed annuity's income payouts depends on several factors, including, but not limited to:

• When you fund the annuity
• How much you put in
• Your interest rate(s) during the accumulation phase
• How long the annuity earns interest at that rate
• If and when you elect to start receiving guaranteed annuity payouts
• Whether you choose to receive payouts for a fixed period or a lifetime
• Whether you choose to receive payouts that remain level or are adjusted for inflation
• Whether you choose a lifetime payout option with a guaranteed payout period to ensure beneficiaries receive payouts through the remainder of that period if you die before it ends

An insurance company can help you understand what fixed annuity payout options—and amounts—are available based on your specific circumstances. That can help you determine what type of contract best suits your goals.

Like any financial product, a fixed annuity offers benefits and drawbacks. Weighing the pros and cons can help you determine if it's a good choice to help you achieve your goals.

• Guaranteed interest. The annuity's value increases over time, unaffected by market performance. Your initial interest rate is locked in for a specified period determined at the time of purchase. After that period ends, the rate may rise or fall depending on your contract terms. A type of fixed annuity called a multi-year guaranteed annuity (MYGA) guarantees a set interest rate for multiple years. When that term ends, you may be able to select a new term, surrender the contract, or do nothing and allow the MYGA to move into a fixed account that earns a guaranteed minimum interest rate.
• Retirement income you can count on. You're guaranteed to receive ongoing annuity payouts that you can elect to begin in retirement and continue for a set period or through the rest of your life.
• Tax-deferred earnings. No taxes are due on earnings while they remain in the annuity during the accumulation phase. That allows more money to build up and accrue interest.
• Potential to pass money to heirs. In most cases, a standard death benefit will be paid to your beneficiaries if you die before the annuity provides any income. Some contracts call for payment of a prorated death benefit if you pass away after you begin receiving income. You may be able to choose other death benefit terms with optional policy riders.

• No benefit from bull markets. With standard fixed annuities, growth is based on a fixed interest rate, so your annuity can't take advantage of positive market performance.
• Potential to collect less than you paid in. Depending on your contract terms, your annuity might provide less in payouts than you paid in premiums. This can occur if you choose to receive lifetime payouts with no guaranteed payout period and then die shortly after income payouts begin. In those circumstances, the annuity won't continue to make recurring payouts to your beneficiaries. You might be able to avoid such a scenario by choosing an annuity with a guarantee period, which ensures that your beneficiaries will receive payouts through the end of that period if you pass away before it's complete.
• Possible inflation impacts. If you choose an annuity contract that doesn't include cost-of-living adjustments for payouts, your fixed rate of return might not keep up with inflation.
• Surrender charges. During their accumulation phase, most fixed annuities require that the money stay in the annuity for a certain period of time. If you make an annuity withdrawal during that period, you may face surrender charges.

To fund a fixed annuity, you have two options: Pay a lump sum or a series of premiums.

• Single-premium fixed annuities. Funded with a one-time lump sum. Often achieved by rolling over a 401(k) or IRA or by using proceeds from the sale of an asset.
• Flexible-premium fixed annuities. Funded with a series of premium payments. The annuity's value grows at your fixed interest rate.

You also may choose between immediate and deferred fixed annuities, which differ based on how quickly you begin receiving guaranteed annuity payouts.

• Immediate fixed annuities. Funded with a single premium. Payouts start within a year—in some cases, within 30 days or immediately.
• Deferred fixed annuities. Can be funded with a single premium or a series of payments. They require a waiting period between the time you start putting money in and the time you've elected to have guaranteed annuity payouts begin. During that period, interest accumulates, which could increase the size of your future payouts.

When you choose to receive guaranteed payouts—also known as annuitization—you may be able to specify the duration of the payouts. Options include lifetime or fixed-period payouts.

Annuity payouts continue throughout your life. Options include:

• Single-life. Provides income until the designated person—known as the annuitant—dies.
• Joint-and-survivor. Provides income through the lives of two annuitants, which may be you and your spouse.

When you elect to receive lifetime payouts, you may opt to include a guaranteed payout period in your contract. If the annuitant passes away before the end of the guaranteed period, payouts will continue to the beneficiary for the remainder of the period. This means the payouts will continue through the life (or lives) of the annuitant(s) or through the guaranteed period—whichever lasts longer.

Guaranteed annuity payouts end on a scheduled date. If you live past that point, you'll stop receiving income from the annuity. If you die before the scheduled end date, income payouts may be allowed to continue to your beneficiary or estate. But that depends on your contract.

An alternative to a fixed annuity is a variable annuity. The difference between fixed vs. variable annuities lies mainly in how they accumulate earnings and change in value.

With a fixed annuity, a guaranteed minimum interest rate ensures a steady rise in value.

With a variable annuity, you invest your premiums in variable subaccounts. The annuity's value fluctuates based on the performance of the investment options you select. You assume the investment risk, and a variable annuity may lose value, including loss of principal.

In addition to fixed and variable annuities, there are other annuity types, including fixed-indexed annuities.

Some or all of the interest a fixed-indexed annuity accrues is based on the performance of a particular market index (for example, the S&P 500). Depending on your contract terms, there may be a cap on the amount of interest you can earn. However, if the index experiences a loss, the annuity's value does not decrease. For some fixed-indexed annuities, interest calculations use a participation rate (for example, 70%) of the index's full return.

Because fixed annuities pose no risk of loss due to market performance, they're not securities. Interest isn't affected by market fluctuations, and the insurance company issuing the product takes on all the risk.

In contrast, variable annuities are considered securities because the interest they accrue is tied to the market performance of subaccounts you select. That means you bear the investment risk. Variable annuities are subject to regulation by the U.S. Securities and Exchange Commission.

Whether you consider a fixed annuity depends on many factors, including your age, your financial goals, your retirement plans, the resources you have available, the amount of risk you wish to take on, and how long you expect to live. Weigh these considerations:

• Have you contributed to your employer's 401(k) plan to receive matching contributions?
• Would you like to put more money away to help support yourself (and, perhaps, your spouse) in retirement?
• Do you want to defer taxes on investment growth until you're retired and potentially in a lower tax bracket?
• Do you want to balance your more aggressive investments with an option that promises a stable, predictable interest rate?
• Can you set aside a lump sum or start making a series of premium payments now?
• Are you comfortable with limited access to those contributions for a period of time, allowing interest to compound?

If your answer to any of the above questions is "yes," a fixed annuity may be worth exploring. Locking in a guaranteed interest rate may help you build confidence in your overall retirement savings plan.

Want to discuss whether a fixed annuity makes sense for you? Connect with a Thrivent financial advisor.