What Is A Fixed Annuity: Learn How Fixed Annuities Work And The Tax Benefits
If you’re like most people, the term “annuity” probably doesn’t bring visions of excitement and adventure to mind. It may even make you a little nervous.
But there’s no need to worry – in this complete fixed annuity guide, we will closely examine what fixed annuities are and how they work. By the end, you should have a good understanding of whether or not a fixed annuity is right for you.
So, let’s get started!
What Is A Fixed Annuity?
A fixed annuity is the most conservative of the top three annuity types. Fixed annuities provide a guaranteed rate of return by investing in low-risk fixed-income assets like bonds or certificates of deposit.
The payout is fixed, meaning that the money you receive is known and determined at the beginning of the contract. This makes fixed annuity rates attractive for investors who want to secure their funds and establish a steady income stream during retirement.
Variable and indexed annuities are alternatives and provide more robust investment options. A variable annuity does not protect your initial investment, whereas a fixed index annuity protects the initial investment and lets you earn higher rates of return.
Fixed annuities contracts provide various features, including
- A maturity date
- Surrender charges
- Optional riders like death benefits and income guarantees
- Tax-deferred growth
How Do Fixed Annuities Work?
A fixed annuity guarantees an established rate of return on the contributions made by the investor for a set period. The investor makes one or several payments to an annuity company, which then promises to pay a fixed return on the contributions, regardless of how the markets perform.
The insurance company determines the interest rate on a fixed annuity based on prevailing market conditions and the length of the annuity contract. Fixed annuities are a low-risk investment option, making them a popular choice for investors who want income certainty and protection for their retirement funds.
One of the key benefits of a fixed annuity is that it provides a dependable source of investment income for retirement. Additionally, fixed annuities are often tax-deferred, meaning that taxes on the earnings are delayed until the investor withdraws the funds.
Fixed annuities can be a valuable addition to a retirement financial plan for those seeking low-risk investment options with guaranteed returns. Talk with a fixed annuity consultant to help you buy a fixed annuity.
Fixed Annuity Options: Deferred Annuity vs. Immediate Annuity
Fixed annuities offer two types of investment options: deferred annuities and immediate annuities—the difference lies in when payments begin and how they are funded.
Deferred Annuities:
A fixed deferred annuity begins to pay out at least one year after purchasing it. During the accumulation phase, the annuity earns interest at a guaranteed rate, which is tax-deferred.
This period can last several years, during which the owner can contribute to the annuity. The payout phase begins when the owner starts to receive regular income payments.
Immediate Annuities:
Immediate annuity begins to pay out within one year of purchase. Usually, a sum of money is used to finance this sort of annuity. The payout phase begins immediately after the contract is signed, and the owner starts receiving regular income payments.
Deferred annuities have a more prolonged accumulation phase before payments begin, while immediate annuities start making payments immediately. The two choices depend on the owner’s financial goals and preferences.
Annuities And Cost-of-Living Adjustments (COLAs)
Fixed annuities pay a set return, but inflation can erode the purchasing power of your annuity income over time. If the individual who owns the annuity desires to deal with inflation, they have the option to acquire a rider that includes the cost of living adjustments (COLAs).
Purchasing a COLA rider ensures that your initial payments are lower and gradually rise over time to match the inflation rate.
Annuities and Required Minimum Distributions
A fixed annuity is a long-term retirement product that can provide guaranteed income payments. Regarding Required Minimum Distributions (RMDs), annuities can be popular.
For example, if you have an annuity in an IRA, you’ll have to start taking RMDs by April of the year after you turn 73. Annuities with lifetime payouts can help ensure you receive a fixed income stream for the rest of your life, meeting or exceeding the RMD requirement.
Fixed annuities, in particular, are a popular choice for meeting RMD obligations. With a fixed annuity, you pay taxes on the deferred earnings in each payment, but the principal portion of the payment is not taxed.
What Are The Advantages Of A Fixed Annuity As An Investment?
1. Guaranteed Payments for Life
A Fixed annuity is an investment that offers a guaranteed income stream for life, making them a popular choice for those who want predictable and reliable payments in retirement. With a fixed annuity, you can set up a guaranteed income stream that will pay you a fixed return on your contributions for the rest of your life, no matter how long you live.
Even if the invested money in a fixed annuity goes to zero, the annuity will continue to pay the same monthly benefit amount. This means you can enjoy peace of mind knowing that you will have a steady source of income in retirement, regardless of market fluctuations or other economic factors.
2. Tax-Deferred Growth
Fixed annuities may be a good option if you’re looking for an investment vehicle that allows your money to grow tax-free. Fixed annuities are tax-qualified vehicles, meaning your investment’s earnings grow and compound tax-deferred.
You only pay taxes when you withdraw money from the account through occasional withdrawals or regular income. Tax-deferred growth can significantly affect how your account builds up over time, especially for people in higher tax brackets.
For example, if you invest $100,000 in a fixed annuity and earn 5% per year after 10 years, your account value would be $162,889. However, if you invested the same amount in a taxable account and paid taxes on the earnings yearly, your account value would only be $127,628 or 21.64% less after 10 years.
3. Protection Against Market Volatility
Market volatility refers to the unpredictable and rapid changes in the value of financial assets due to various economic and political factors. It poses a significant risk to investors who seek to grow their wealth through market participation.
However, fixed annuities provide a secure investment option that shields investors from market fluctuations. With fixed annuities, investors can earn a guaranteed interest rate without exposure to market risk.
4. Ability to Choose Payments
A fixed annuity is a contract allowing you can choose from different payment options based on your financial goals. Depending on the type of annuity contract you establish, you have the following payment options:
- The first option is a set payment amount, which means you receive a fixed amount at regular intervals for a specific period. This option provides predictable income and is suitable for people who want to cover their basic expenses.
- The second option is flexible payments, which allows you to withdraw money as needed, subject to certain limitations. This option suits people who want access to their money but still want to earn interest.
- The third option is a life-only payment, which provides a guaranteed income for life but ends when you die. This option suits people who want a steady income for the rest of their lives.
5. Low-Risk Investment Option
The benefit of fixed annuities is a low-risk investment option that offers a guaranteed interest rate for a fixed period without exposure to market fluctuations. This makes it an excellent option for those who want to save money on taxes and receive a reliable source of income during retirement.
The rates are generally higher than traditional savings vehicles, and earnings grow tax-deferred. Additionally, the principal is protected from market downturns, making it a safe investment option.
6. Retirement Income Benefits
Investing in a fixed annuity can provide several retirement income benefits.
- Predictable income for life, even if the contract value is reduced to zero.
- A fixed annuity can protect your income from market risk, which is especially important as you are near retirement age.
- You can also access money for emergencies, which can be helpful for unexpected expenses.
- A fixed annuity can provide a way to grow your future income every year until your lifetime income begins.
7. Stream of Cashflow for Life
A fixed annuity provides a guaranteed lifetime income that is easy to understand and integrate into your income strategy. Annuities allow you to deposit a lump sum into an account, which then grows tax-deferred until you start receiving payments.
When you’re ready to receive payments, you can choose to annuitize your contract, which means you’ll receive a set payment for a specified period or a lifetime income stream. The lifetime income option ensures a steady cash flow stream for as long as you live, even if the contract value is reduced to zero.
In contrast, if your 401k or IRA runs out of money, payments will come to a screeching halt.
8. Possibility of Growth and Bonus Payments
While having a fixed rate of return is nice, some fixed annuities offer bonus payments to investors. These bonuses are typically calculated as a percentage of the premium paid and are added to the account value at the end of the contract term.
While fixed annuities are the most basic, they can include some nice enhancements promised in the annuity contract.
9. Protection of Beneficiaries’ Money
Fixed annuities provide beneficiaries a secure way to invest and plan for the future. Beneficiaries can save money on taxes, receive guaranteed interest for a set period, withdraw funds as needed, and even receive guaranteed income for life.
10. Access to Professional Advice
Access to professional advice can be a valuable benefit of buying a fixed annuity. Annuity consultants can guide in choosing suitable investments based on an individual’s situation.
As your annuity expert, Integrity Now Insurance Brokers help our clients fully understand their annuity contract’s terms, fees, and expected rate of return. Our financial advisor lets individuals make more informed decisions about their annuity investments and potentially maximize their retirement savings.
What Are The Disadvantages Of A Fixed Annuity
Fixed annuities provide a guaranteed income and safety, but they also have several disadvantages that investors should consider.
These include the following disadvantage:
- Fixed annuity contracts can be complex, with many clauses and benefits that can be difficult to understand.
- Variable annuities come with high annual fees, which can eat into the returns.
- Fixed annuities are illiquid; early withdrawal can result in surrender fees and penalties.
- The counterparty risk can be high, as the annuity is only as good as the company you sign with.
- Exposure to inflation is a concern, as the fixed income stream may not keep up with inflation, resulting in a loss of purchasing power.
- Fixed annuities lack flexibility and growth potential, and payments are taxed as ordinary income.
Fixed annuities are like a CD but provide broad tax advantages and higher interest rates. Fixed annuities are often used as an alternative option to CDs and bonds.
It is essential to consider the pros and cons of annuities before investing and committing to a long-term annuity contract.
How Does a Fixed Annuity Compare to Other Annuities?
Fixed Annuity vs. Fixed Index Annuity
Both Fixed Annuities and Fixed Index Annuities offer a guaranteed minimum interest rate and offer a steady stream of income for life. The primary difference between the two is how they accumulate interest.
Here are some of the differences between a fixed annuity and a fixed index annuity:
- Fixed Annuities offer a set payout
- Fixed Index Annuities track a stock market index, such as the S&P 500, and offer higher payouts based on the index’s performance.
- Fixed Annuities offer more stability and predictability
- Fixed Index Annuities provide the potential for greater earnings but may offer lower minimum fixed returns
- Fixed Annuities and Fixed Index Annuities protect the principal from market losses
Fixed Annuity vs. Variable Annuity
Fixed and variable annuities are insurance contracts that differ wildly in how they pay interest on the account owner’s contributions.
- A fixed annuity promises a guaranteed rate of return. It is low-risk, has a meager fee, and easy-to-understand option that may appeal to conservative investors.
- A variable annuity pays interest that fluctuates based on the performance of an investment portfolio chosen by the account owner. Variable annuities are not considered safe investments and come with extremely high fees.
Integrity Now Insurance Brokers does not recommend variable annuities, as fixed annuities earn guaranteed interest and will not detract from your account value. We recommend fixed index annuities and fixed annuities, as both are considered safe money options.
Annuities At A Glance
| Variable Annuity | Fixed Index Annuity | Fixed Annuity | Immediate Annuity | Deferred Income Annuity | |
|---|---|---|---|---|---|
|
Principal Protection |
No |
Yes |
Yes |
Yes |
Yes |
|
Access To Principal |
Yes |
Yes |
Yes |
No |
No |
|
Control Over Money |
Yes |
Yes |
Yes |
No |
No |
|
Control Over Money |
Yes |
Yes |
Yes |
No |
No |
|
Tax-Deferred Growth |
Yes |
Yes |
Yes |
No |
No |
|
Guaranteed Growth |
No |
Yes |
Yes |
No |
No |
|
Guaranteed Income |
Yes |
Yes |
Yes |
Yes |
Yes |
|
Inflation Protection |
Yes |
Yes |
No |
Yes |
Yes |
|
Death Benefit |
Yes |
Yes |
Yes |
Yes/No |
Yes/No |
|
Long-Term Care Benefits |
Yes |
Yes |
Yes |
No |
No |
How Do You Choose The Right Fixed Annuity For You?
Step 1: Understand your needs
Fixed annuities earn interest that is guaranteed for a fixed period of time, typically 1 to 10 years. Some investors are risk-averse and do not want to be involved in any risk, which makes CDs, bonds, and fixed annuities an excellent option.
Working with a financial consultant allows for an open conversation about your financial needs, and they can help identify which type of investor you are.
We will start by evaluating your age, retirement goals, risk tolerance, and financial situation. Our annuity experts will help you learn about fixed annuities and their benefits.
Step 2: Choose a time period
Short-term annuities typically have lower interest rates but offer more flexibility regarding when you can receive your payments. Long-term annuities, on the other hand, usually have higher interest rates but require a longer commitment.
In 2023, long-term annuities are experiencing lower rates than short-term due to high inflation and fast-rising interest rates. This will adjust as the economy becomes more stable.
To determine the length of time you need to lock in your money, consider factors such as your age, retirement goals, and financial situation.
If you’re younger and have more time until retirement, a longer-term annuity may be a better option, giving your money more time to grow. If you’re closer to retirement age, a shorter-term annuity may be more suitable as it will allow you more flexibility in accessing your money.
Step 3: Take out some money
To invest in an annuity, you will need access to cash. These funds can come from your checking, savings, CDs, bonds, 401k, and IRA.
Depending on where the money is coming from will determine the type of annuity that is established. Funds from an IRA can take longer to obtain from your current investment company.
Step 4: Read industry reviews and compare rates
When considering a fixed annuity, it is vital to research by working with an independent annuity advisor. They will provide insight into which annuity companies are highly rated by independent rating agencies like A.M. Best to see the financial strength and stability of the annuity providers you’re considering.
Integrity Now Insurance Brokers will review the different types of fixed annuities available, such as multi-year guarantee annuities and traditional fixed annuities, with you to help you decide which annuity will pay you the most.
Step 5: Research available fixed annuities options like lifetime benefits, income ranges, and types
Fixed annuities are insurance contracts that offer a guaranteed interest rate and principal protection. They provide a steady and reliable source of income that can last for life. Here are some of the various fixed annuity options available to investors:
- Lifetime Income: Investors can choose to annuitize their contract for lifetime income. They can choose from different payout options, such as fixed payments for a specified period or a lifetime income stream.
- Income Ranges: Fixed annuities offer a variety of income ranges, from low to high, depending on the investor’s financial circumstances and goals.
- Tax-Deferred Growth: Fixed annuities grow tax-deferred, meaning investors won’t have to pay taxes on their earnings until they withdraw them and start receiving income.
- Death Benefit: If something happens to the investor before their contract matures, their beneficiaries will receive the death benefit in their agreement.
- Guaranteed Interest Rate: Fixed annuities offer a guaranteed interest rate based on the insurer’s financial strength and the guaranteed rate time.
- Fees and Charges: Investors should check the fine print of annuity contracts for fees, surrender charges, and rider costs.
- Rider Options: Discover the riders provided by the annuity supplier and assess if there are any riders you wish to include in your annuity.
Step 6: Contact An Annuity Expert
Choosing the right fixed annuity can be complex, so seeking professional advice is crucial. An annuity expert can help you navigate the various options and tailor a solution to your unique needs.
Integrity Now Insurance Brokers can also provide free annuity quotes and help you understand your fees and terms. Contact one of our Fixed Annuity consultants today to learn how we can help you secure your financial future.
Types Of Fixed Annuities Available For Retirement Income
1. Fixed Annuities
There are several types of fixed annuities available on the market. The most basic type of fixed annuity guarantees a fixed interest rate for a specified period, usually one to ten years.
2. Guaranteed Annuities
Guaranteed annuities are a type of fixed annuity that can provide investors with a long-term investment option that guarantees income payments in the future. With a guaranteed annuity, investors make one or several payments to an annuity provider, who promises to pay a fixed return on their contributions, regardless of how markets perform.
The initial investment and any accrued interest are fully protected against loss, and any outstanding amounts are credited to the cash value at the current interest rate established by the insurer. Additionally, credited interest will never exceed the guaranteed minimum rate stipulated in the annuity contract.
One of the key benefits of guaranteed annuities is that they offer guaranteed income for life, making them the only investment product that can provide this level of security. They also offer tax-deferred growth potential, protection against market fluctuations, and higher payouts than comparable investments that provide income.
Multi-year guaranteed annuities (MYGAs) are a specific type of guaranteed annuity that offers a guaranteed return for retirement savings.
3. Variable Annuities
Variable annuities differ from fixed annuities, offering higher growth potential but carrying more risk. While fixed annuities provide set payouts, variable annuities allow policyholders to earn larger payouts over time, depending on the performance of the investments made within the annuity.
4. Equity-Indexed Annuities
Equity-indexed annuities (EIAs) are fixed annuities that offer the potential for higher returns than traditional ones. EIAs are linked to a stock market index, such as the S&P 500, and provide a guaranteed minimum interest rate, potentially earning additional interest based on the index’s performance.
The investor is protected from market losses but also has a cap on potential gains. EIAs are less risky than variable annuities but offer higher potential returns than traditional fixed annuities.
EIAs may be a suitable investment option for those who want to participate in the stock market without the risk of losing their principal.
5. Annuities with Life Coverage
A life annuity is a fixed annuity that provides a guaranteed income stream for life and a death benefit for beneficiaries. Unlike other fixed annuities that only offer a standard death benefit, annuities with life coverage provide various types of life coverage, such as single life and joint life coverage.
Single life coverage provides income for the annuitant’s life only, while joint life coverage provides income for the lives of both the annuitant and their spouse. The drawback of joint life coverage is that the payout amount is typically lower than single life coverage.
6. Annuities with Pension Rider
An annuity with a pension rider is a fixed annuity offering a guaranteed stream of income payments for life, with the option to add a rider that adjusts the annuity payments to keep up with inflation. This type of annuity can provide a reliable source of income during retirement while protecting your principal and providing a guaranteed death benefit to your loved ones.
7. Single-Payment Annuities
A single-payment annuity is a type of annuity that requires a one-time payment in exchange for a guaranteed income stream for a specific period or for life. The benefits of a single-payment annuity include a guaranteed income stream, protection against market volatility, and tax-deferred growth.
A single-payment annuity may be a good investment option for individuals with a lump sum of money who want a guaranteed income stream for retirement. It can also be a good option for individuals who wish to diversify their retirement income sources and reduce their reliance on Social Security or other retirement savings.
Finally, a single-payment annuity may be a good option for individuals who want to leave a legacy for their heirs, as some annuities offer death benefits. It is essential to carefully consider the terms and conditions of the annuity contract, understand any tax penalty, and consult with our annuity advisors before making any investment decisions.
8. Annuity Conversions
An annuity conversion is changing one type of annuity to another. In the context of fixed annuities, a deferred fixed annuity can be converted into an immediate fixed annuity at any time the owner chooses.
This conversion results in a guaranteed income payout for a specified period or the annuitant’s life. Vice versa, an immediate fixed annuity can be converted into a deferred fixed annuity, allowing the owner to accumulate funds for a future payout.
What are the pros and cons of fixed annuities?
Fixed annuities possess a great benefit of being secure and guaranteeing premium safety while also providing the option to establish a consistent source of income that one cannot outlive. These investments are straightforward and dependable, which makes them attractive to individuals who are cautious with their financial choices.
Fixed annuities provide guaranteed returns, leaving out the guessing and risk, and a guaranteed income that does not fluctuate due to stock market swings.
Despite its straightforwardness and reliability, this particular annuity product lacks the growth potential of more complex options. Fixed annuities cannot adjust for inflation.
Additionally, money tied up in an annuity cannot be withdrawn without penalties or surrender charges, making them illiquid.
How are fixed annuities taxed?
Fixed annuities are tax-qualified vehicles that grow and compound tax-deferred. Gains that are withdrawn incur regular income tax during the year they are withdrawn.
Non-qualified fixed annuities are funded with after-taxed money, and annuity owners are subject to paying regular income taxes on any interest credits that have yet to be taxed.
Qualified fixed annuities are pre-taxed funds, so when you withdraw funds from the account, 100% of your income will be subject to ordinary income taxes. If you withdraw funds from a qualified annuity prior to turning 59 ½, you will likely face a penalty of 10% on the taxable segment of the withdrawal.
What are the different types of fixed annuities?
Three main types of fixed annuities exist traditional, index, and multi-year guaranteed annuities.
- Traditional fixed annuities offer a fixed rate of return for a specific period, usually one to ten years, based on prevailing interest rates.
- Index annuities are tied to an equity market index, and the index’s performance determines the rate of return.
- Multi-year guaranteed annuities offer a guaranteed rate of return for a more extended period, typically three to ten years. F
Why Do Retirees Prefer Fixed Index Annuity Over Fixed Annuities?
Retirees may prefer fixed index annuities over fixed annuities because they offer the potential for higher returns while still protecting against market downturns. Unlike fixed annuities, fixed index annuities allow investors to participate in the stock market gains while providing a minimum guaranteed return.
This can be especially beneficial for retirees concerned about inflation who want to ensure their retirement income keeps up with rising costs. Another advantage of fixed index annuities is the ability to lock in gains and protect against market losses.
For example, if the stock market experiences a downturn, the investor’s principal is protected, and they do not lose any money.
How much money do you need to purchase a fixed annuity?
The minimum amount required to purchase a fixed annuity offered by insurance companies can range from a few thousand dollars to over a million dollars. The fixed rate of interest is determined by time and dollars invested.
Are there any risks associated with investing in a fixed annuity?
While risks are associated with any investment, fixed annuities are generally considered a safe option due to guaranteed rates of return and insurance company backing. The Department of Insurance regulates fixed annuities and the companies that represent them.
Get Help Buying A Fixed Annuity: Integrity Now Insurance Brokers
Buying a fixed annuity can be complicated, requiring much financial knowledge and experience. Choosing a reputable and trustworthy annuity broker to help you navigate this complex financial product is essential.
Integrity Now Insurance Brokers is a company that specializes in fixed annuities and provides expert guidance to its clients. With their extensive industry knowledge and experience, they can help you find the best-fixed annuity for your unique needs and financial goals.
One of the main benefits of working with Integrity Now Insurance Brokers is that they work with various insurance carriers, allowing you to compare and contrast multiple fixed annuity options. This ensures you receive the best possible rates and terms for your investment.
Their team comprises experienced and licensed insurance agents dedicated to putting your interests and needs first. They work hard to understand what you need from an annuity, including goals, preferences, and risk tolerance, to ensure they find your best fit.
Contact them today to schedule a consultation.
