As you plan for retirement, you may come across fixed annuities.
When it comes to these investment vehicles, many times people have two basic questions: What is a fixed annuity and how does it work?
An annuity is a contract issued by a life insurance company. As the contract holder, you give the insurance company a lump sum or a series of payments over time.
In return, the insurance company agrees to do the same, either immediately or at some point in the future.
With a fixed annuity, the insurance company guarantees the interest rate you will earn on the funds you deposit for a specified period of time.
Benefits of a fixed annuity
When it comes to fixed annuities, there are a variety of benefits that could fit your retirement needs.
Here are some of the basic benefits:
Tax deferred growth — Annuities are tax-deferred, meaning you don't pay taxes on any growth until you start receiving payments. For many, this can be an attractive benefit for more potential income growth over the long run.*
Competitive fixed yields — Because fixed annuity rates are set by insurance companies based off the earnings of their own investment portfolios, the rates are often higher than comparable low-risk investments, such as certificates of deposit (CDs).
Guaranteed minimum rates — The guaranteed minimum rate of a fixed annuity can help reduce certain risks associated with long term retirement investments.
Guaranteed income payments — Fixed annuities can provide guaranteed income payments for retirement. Many fixed annuities have flexibility with payouts, as well, with options for a set period of payments to payments that continue for life.
Beneficiary protection — Annuities also provide some protection for your named beneficiary to avoid probate. Depending on the contract, you can either pass on your investment (less any withdrawals) or the contract value should you die before beginning your annuity payout. Death benefits that equal the contract value often come with an additional fee, however.
Fixed annuities and retirement
Preserving and accumulating capital to carry into retirement is a major concern for millions of Americans. Given there's always a risk with investments due to the fluctuating market, many have considered fixed annuities as an option to help mitigate volatility.
When looking at your entire financial picture, you — alongside your investment advisor — may find that a fixed annuity could potentially help meet your needs or provide a bridge into the next stage of your retirement.
Keep in mind that since annuities are long-term investments, there are tax penalties for withdrawals made by anyone under the age of 59 1/2. It's also important to note that withdrawals can reduce your overall future benefit and value; withdrawals are also subject to income tax. Another very important characteristic of annuities that must be regarded when considering withdrawals is the surrender charge period. During this period, which is often the first 3-10 years of a contract, any withdrawals will be subject to a significant charge. Furthermore, if made before the age of 59 1/2, the aforementioned early withdrawal tax penalty would apply. Most fixed annuities do allow for an annual surrender charge-free withdrawal of 10% of the contract value, however.
*Annuity payments from a tax-qualified plan will be fully taxable as ordinary income. Annuities are intended as vehicles for long-term retirement planning, which is why withdrawals reduce an annuity's remaining death benefit, contract value, cash surrender value and future earnings. Annuities also may be subject to income tax and, if taken prior to age 59 ½, an additional 10% IRS tax penalty may apply.