An annuity is a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. You buy an annuity either with a single payment or a series of payments called premiums.
Some annuity contracts provide a way to save for retirement. Others can turn your savings into a stream of retirement income. Still others do both. If you use an annuity as a savings vehicle and the insurance company delays your pay-out to the future, you have a deferred annuity. If you use the annuity to create a source of retirement income and your payments start right away, you have an immediate annuity.
What is a Fixed Annuity?
With a fixed annuity, the insurance company guarantees both the rate of return (the interest rate) and the payout to the investor. Although the word "fixed" might suggest otherwise, the interest rate on a fixed annuity can change over time. The contract will explain whether, how and when this can happen. Often the interest rate is fixed for a number of years and then changes periodically based on current rates. Payouts can be for an entire lifetime, or you can choose another time period.
While you are accumulating assets in a deferred fixed annuity, your investment grows tax-deferred. The insurance company agrees to pay you no less than a specified rate of interest during the time that your account is growing. With an immediate fixed annuity—or when you "annuitize" your deferred annuity—you receive a pre-determined fixed amount of money, usually on a monthly basis (similar to a pension). These payments may last for a specified period, such as 25 years, or an unspecified period such as your lifetime or the lifetime of you and your spouse.
The predictability of a fixed annuity makes it a popular option for investors who want a guaranteed income stream to supplement their other investment and retirement income. Fixed annuity payouts are not affected by fluctuations in the market, so they can provide peace of mind for investors who want to ensure that they will have enough money to carry them through retirement and cover identified future expenses.
Things to Consider
While a fixed annuity can remove market risk from your returns, there are other risks to consider when deciding if a fixed annuity is for you.
- An annuity's "guarantee" is 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, but annuities are not guaranteed by the FDIC, SIPC or any other federal agency if the insurance company that issues the contract fails.
- Payments in a fixed annuity typically do not have cost-of-living adjustments to keep pace with inflation, so the value of the money you receive in your payments may decline over time. Annuities with inflation protection can be purchased but the cost, in general, is significantly higher.
- It may be difficult to get your money back once you pay the premium to the insurance company. Even if you only receive a few payments under a fixed annuity contract, the insurance company may not be obligated to continue payments to your spouse or refund your premiums to your estate.
- If there are changes to your fixed annuity and you want to withdraw your money early, you could incur surrender charges that cut into your returns.
Fixed Annuity Regulation
Fixed annuities are regulated by state insurance commissioners. Be sure to check with them to confirm that your insurance broker is registered to sell insurance in the state, and inquire about whether your state has a guaranty association that provides some level of protection if an insurance company doing business in that state fails.
The following resources provide additional information about fixed annuities, their risks and benefits, and whether this type of investment is the right choice for you.
- National Association of Insurance Commissioners:
- Insured Retirement Institute: Annuities Regulation and Industry Information
- SEC: Annuities