A fixed annuity may help you accumulate retirement savings without an annual tax bill cutting into your earnings. It also may provide guaranteed income backed by the strength of the insurance company that issues your annuity contract.
You might choose a fixed annuity to supplement other sources of guaranteed income, like Social Security or a pension. Fixed annuities can provide a stable income to cover your essential expenses in retirement no matter how the investments in your IRA are performing.
Fixed annuities have benefits and drawbacks. Understanding both can help you decide whether a fixed annuity is the right financial product for you.
Fixed annuities basics
There are two phases with a fixed annuity: an accumulation phase and a distribution phase. During the accumulation phase, you put money into your annuity by paying premiums. You might pay a single premium upfront or a series of premiums over time. Your premiums earn interest at a guaranteed rate that's backed by the financial strength of the insurance company that issues the contract. (Note that fixed annuities are not backed by the FDIC like bank-related accounts are or by the SIPC like brokerage accounts are.)
During the distribution phase, you can receive regular payments. These are usually monthly and can continue for a set period, such as a number of years, or for an indefinite period, such as the rest of your lifetime or your spouse's lifetime.
The typical fixed annuity buyer is at least 50 years old and focused on financial security for retirement. They also may have maxed out their retirement contributions and be seeking additional tax-deferred ways to save.
Pros of fixed annuities
There are several benefits of fixed annuities that may fit with your overall financial strategy.
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.
When you buy a fixed
Guaranteed rate of return
Reliable retirement income
Fixed annuities have 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.
Easy to understand
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.
Cons of fixed annuities
A fixed annuity is not the right choice for everyone. Here are the main drawbacks you should understand.
No inflation protection
A fixed-rate annuity may not keep up with inflation. The inflation rate may be higher than the guaranteed rate your annuity contract pays.
A fixed annuity is a long-term contract where you trade liquidity for guaranteed income. Should you change your mind and wish to
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. To compensate, you might choose to take more risk in your investment portfolio to potentially generate more discretionary
Tax on earnings
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 rates depending on your tax bracket.
Payments can end
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.
Alternatives to fixed annuities
If the cons of fixed annuities outweigh the pros for you, consider whether one of these
Fixed indexed annuities
If you'd like more opportunity for growth with safeguards to protect your premiums, a
Instead of low risk, you might prefer high growth.
Help with weighing your options