Individuals who are semi-retired, about to retire, or already retired may choose fixed annuities to help stabilize their income from investments. Fixed annuities are insurance contracts. They offer the person who owns the annuity a set amount of income at regular intervals up to a specified point in time or a specified event, such as the annuity owner’s death. Investing in fixed annuities has both advantages and disadvantages for the investor.
How Do Fixed Annuities Work?
Financial institutions and life insurance companies offer fixed annuities for a lump sum, or for payments on a periodic basis, if the person purchasing the annuity is still working. Money invested in the annuity is guaranteed to earn a fixed rate of return throughout the accumulation phase (while you are still paying into it). During the annuitization phase (when money is being paid out), the balance of your investment, minus payouts, will continue to grow at the same fixed rate.
Pros & Cons Of Fixed Annuities
Fixed annuities can be an attractive investment option for several reasons, including the following:
- Guaranteed rates: With fixed annuities, you know exactly what your rate of return will be for a set period of time. If you want a predictable income stream, this may be a better alternative than other options.
- Long-term income stream: Fixed annuities continue to pay out for the long term, until the specified time period has expired, or the owner is deceased. They can help ensure you have something to supplement Social Security in your “Golden Years.”
- Tax-deferred distributions: Tax-deferred status is a definite benefit of annuities. You do not pay a dime in taxes until funds are withdrawn.
As with most things, there are also disadvantages to consider when investing in fixed annuities:
- An annuity pays out until the owner’s death – it cannot be left to a beneficiary in most cases. Term fixed annuities pay out over a set time period, after which no more payments are made. If the owner dies before the end of the term, the company selling the annuity keeps the remaining funds.
- A joint life with last survivor annuity will allow the spouse of the owner to be a beneficiary and continue receiving payments until his or her death. However, this type of annuity costs considerably more.
- Lack of liquidity is another concern with fixed annuities. Many are sold with a surrender fee, which is a substantial sum incurred if you try to withdraw funds within the first few years of your contract. This surrender period can last from six to eight years, or even longer.
- Although tax-deferred status is a major advantage of fixed annuities, when you take withdrawals, your net returns are taxed as ordinary income. This could be costly, depending on your tax bracket.
- Complexity is another disadvantage of fixed annuities. Many come with complex fees and limitations that few investors are able to fully understand.
If you are uncertain about whether to invest in fixed annuities, our friendly agent can help. We invite you to consult with us about the pros and cons.