Are fixed annuities a good investment? 10 pros & cons to help you decide

As long-term contracts backed by the insurance company that issues them, fixed annuities can provide you with low-risk growth and predictable income later in life. It's money you can count on to help cover your essentials in retirement rather than only hoping your market-based retirement accounts perform well. But fixed annuities are not without certain drawbacks.

When deciding whether fixed annuities are a good investment, you'll need to consider your wider financial strategy. Some people find fixed annuities to be a smart choice after maxing out IRA and 401(k) retirement contributions because they offer a guaranteed specific rate for a set period time. But this reliability can mean your money isn't very accessible and that earnings potential is limited.

It's important to fully understand the advantages and disadvantages of fixed annuities. Gaining a balanced perspective can help you decide if a fixed annuity is the right investment for you.

A fixed annuity is a relatively simple and lower-risk financial product. People often choose them because they guarantee a specific interest rate for a set period of time. That predictability can be comforting to people looking to preserve their assets.

With fixed annuities, you accumulate money by paying premium—either a single one upfront or a series of premiums over time. Over a set period of time, your fixed annuity is guaranteed a specific rate from the insurance company.

When you come to the end of your selected period of time, you can opt to receive regular payments—usually monthly—that continue either for a set period, such as a number of years, or the rest of your life.

The benefits of a fixed annuity include built-in guarantees, tax advantages and simplicity.

You won't lose money in a fixed annuity when the market declines. The insurance company takes on all the investment risk, and it invests its assets conservatively to protect its ability to pay contract holders. In addition, many contracts allow you to name a beneficiary to receive your annuity's full accumulated value when you die.

Not all annuities offer this promise, but fixed annuities do. They have the least risk and the most predictability of the various types of annuities. You'll know at the time you buy your contract what interest rate it will pay. The guarantee of a fixed annuity may help you feel comfortable taking on more risk with other types of investments.

When you buy a fixed deferred annuity, you won't pay taxes on the growth in your annuity's value each year, which can help its value grow faster through compound interest. You'll only pay taxes when taking withdrawals.

Fixed annuities offer several income options: fixed period, specified amount, single life and joint life. Choosing a lifetime income option can help protect against the risk of outliving your assets. Whichever option you choose, you'll know up front exactly what your monthly payout will be.

Some people have an unfavorable impression of annuities because some annuity contracts can be difficult to understand. Fixed annuities, however, are relatively simple. Reviewing them with a financial advisor can help you decide if fixed annuities are a good fit for you.

A fixed annuity is not the right choice for everyone. The main drawbacks are around limited growth, penalties for early withdrawals and taxation of earnings.

The benefit of guaranteed returns comes with the drawback of limited upside. When the market performs well, your fixed annuity will not pay anything extra. Choosing a fixed annuity for its stability and security means forgoing the possibility of high returns on your premiums.

A fixed annuity is a long-term contract in which you sacrifice liquidity for guaranteed income. Should you change your mind and wish to withdraw money from your annuity during the surrender period, which usually lasts several years, you typically will forfeit a percentage of your withdrawal—perhaps as high as 9%—to the insurer.

This penalty may be waived under certain circumstances, but if you have to pay it, it may be higher than the returns you've earned, causing you to lose money. You also may pay a 10% tax penalty on withdrawals before age 59½.

The earnings from your annuity have the benefit of being tax-deferred but also have the drawback of being taxed as ordinary income. By comparison, gains from the sale of investments held for one year or longer are taxed at long-term capital gains rates, which can be significantly lower than ordinary income tax rates depending on your tax bracket.

A fixed-rate annuity may not keep up with inflation. The inflation rate may be higher than the guaranteed rate your annuity contract pays.

Depending on the contract you choose, fixed annuity payments can terminate when you die and leave nothing for your loved ones. And certain payout options—fixed period and specified amount—may end before you die.

Depending on your personal investment objectives, a fixed annuity may be a good investment choice for you. They're a secure type of annuity with predictable income and are generally considered low risk.

Typically, people use a variety of financial products to meet different needs, so a fixed annuity may not be the right fit for what you're looking for. Someone primarily seeking growth rather than reliable income might want to invest in dividend stocks. Or if you want inflation protection and liquidity, you might check out a money market mutual fund. Your financial advisor is an excellent resource for discussing the best tools for achieving your goals.

4 types of annuities:
Which is right for you?

Need a refresher on the other types of annuities?
How you build your retirement funds and then convert them into guaranteed income will depend on the type you purchase.

Compare annuities

After weighing the risks and potential benefits of fixed annuities, you might decide that another type of annuity or a different product entirely is a better fit for your preferences and risk tolerance. Here are some options that are similar to fixed annuities:

If you'd like more opportunity for growth with safeguards to protect your premiums, a fixed indexed annuity could be right for you. It lets you benefit from a limited amount of the growth of a market index, such as the S&P 500 while protecting you against losses in years when the index doesn't perform well. Fixed indexed annuities also have a fixed account that returns a guaranteed interest rate. However, this annuity's lifetime income benefit has an additional charge that fixed-rate annuities do not.

A multi-year guarantee annuity (MYGA) is a fixed deferred annuity that offers tax-deferred growth and avoids market volatility, providing a steady income stream when you need it most. MYGAs guarantee a fixed interest rate for a set period of time, usually between three and nine years. If you need your money back early, you may pay a penalty.

Instead of low risk, you might prefer higher growth opportunities. Compared to fixed annuities, variable annuities offer the potential for higher returns in exchange for the contract holder taking on more risk through investing in subaccounts. Note that variable annuities can be more expensive than other types of annuities, and your monthly payouts can fluctuate with changes in the market.

A certificate of deposit (CD) could be better than a fixed annuity if you have a short-term goal. CDs involve keeping a certain amount of money in an interest-bearing account with a financial institution for as little as a few weeks or as long as several years. The rate is generally locked in and guaranteed for the length of the term. When the term is up—that is, it "matures"— you can withdraw your deposit and the earnings or just a portion, or you may be able to renew it at a new rate and/or term. If you close your CD before it matures, however, you may have to pay a fee and give up some interest.

A financial advisor can explain whether the benefits of a fixed annuity would outweigh the drawbacks in your circumstances. They can help you create a comprehensive retirement strategy and evaluate whether annuities make sense as part of that plan.