This is Part Four of a Six-Part series on annuities. Part One, an Introduction to Annuities, can be found here.
When it comes to managing retirement income, one route to follow is an annuity that provides pension-like payments that you can count on month after month. These types of annuities are called fixed annuities.
The predictability of fixed annuities makes them a popular option for investors who want a guaranteed income stream to supplement their other investment and retirement income. Payments are not affected by fluctuations in the market, so they can provide peace of mind for those who want to carve out a certain amount of income they can count on through retirement.
There are a number of different kinds of fixed annuities. Here’s a look at a couple you might come across.
Fixed Immediate Annuities
One type of fixed annuity is the fixed immediate annuity. This product functions much like a do-it-yourself pension.
An individual hands over a lump sum payment to an insurance company in exchange for a dependable income stream that comes immediately or soon after. This income stream is a “fixed” amount, paid out incrementally by the insurance company, for a certain period of time, such as the life of the customer.
With few employers offering pensions anymore, pension-like products like the fixed immediate annuity can fill in the gap by offering some amount of monthly income for life. The downside, however, is that your heirs may not get the money from the annuity when you pass away if the annuity includes a life-only payout option.
Fixed Deferred Annuities
Another type of fixed annuity is the fixed deferred annuity, where you hand over money for a specified period. The insurance company guarantees your money will earn a certain rate of return and that your principal will be protected.
“You temporarily lock up your money in exchange for a promised guaranteed interest rate,” said Todd Giesing, senior business analyst at LIMRA Secure Retirement Research.
In addition to their predictability, fixed deferred annuities have other features that might appeal to some investors, including low investment minimums, sometimes starting at around as $1,000.
And this type of annuity generally comes with death benefits. That means if the annuity owner dies before payouts begin, the beneficiary receives the current contract value of the annuity.
Risks to Keep in Mind
Here are some other things to keep in mind if you’re considering purchasing a fixed immediate or fixed deferred annuity:
You limit your ability to leave a legacy bequest. While a fixed immediate annuity may be a good option for someone looking for a steady, dependable payment, they can limit your ability to leave behind money for your heirs since payments may stop upon your death. If your intent is to transfer your wealth at death, it’s a good idea to consult an estate planning professional when considering annuities to determine how well they fit into your plan.
Your interest rate might change over time. Fixed deferred annuities promise you a guaranteed minimum interest rate — the lowest possible interest rate you can earn. But while the word fixed might suggest your interest rate will always be the same, that’s not necessarily the case.
Your rate might be fixed for a period, say one year, and then change periodically based on rates declared for the coming year by the insurance company. It’s important to read the contract to understand how and when this might occur. Additionally, the insurance company may offer a very attractive first year rate to get you to buy its contract, but those rates won’t be guaranteed beyond the first year.
“You may find yourself trapped for years in an investment that pays you less and less interest every year if you neglect to read the fine print in the contract,” writes Kerry Pechter in “Annuities for Dummies.”
All Fixed Annuities
You face interest rate risk. Whenever you lock in a rate, whether with a fixed deferred annuity or a CD, you face the risk that you will miss out in the event interest rates move up.
Like other types of annuities, fixed annuities are not FDIC-insured. As is the case with all annuities, guarantees are only as strong as the insurance company that issues the annuity.
There may be state guarantees in the event of an insurance company’s failure. Nonetheless, it’s important to check out the insurance company’s ratings from such ratings agencies as A.M. Best, Moody’s, Fitch, and Standard & Poor’s.
Like other types of annuities, early withdrawals could hurt you. As with many annuities, if you want to withdraw your money early from a fixed annuity, you could incur surrender charges that would cut into your returns or your original principal investment.
Moreover, withdrawals made before you turn 59 ½ generally trigger a 10 percent tax penalty on the earnings portion of the distribution, with the IRS treating the distribution first as earnings and profits.