Buying a fixed annuity can be a daunting task.
You have the hordes of self-proclaimed financial experts telling you to avoid them like the plague, and you have your own planner telling you that you should not listen to all of the negative press.
Fixed annuities are not an altogether difficult financial product to understand, but the majority of individuals don’t really grasp their basics.
Understanding these few principals is paramount to making wise investment decisions and determining the best avenues for your hard-earned money.
What is a Fixed Annuity?
The fixed annuity definition is actually fairly easy to explain.
A conventional fixed annuity is simply a financial product that pays a fixed dollar amount for a specific period of time to the investor.
The fixed portion is in reference to the “fixed dollar” portion of the product.
Fixed annuities are often offered through the insurance company, allowing you to buy annuities through your insurance agent.
Different types of annuities require different types of licenses to sell. If you need more information on who should be able to sell annuity contracts, see our article on selling annuity payments.
In contrast to a fixed annuity is a variable annuity.
Variable annuities are insurance products that rather than pay out a fixed dollar amount each time, they pay out a variable amount.
These types of contracts are often associated with stock markets and other market based investments.
The license to sell this sort of annuity is different than that of simply selling fixed annuities.
Correspondingly, most consider variable annuities to be a higher risk product than fixed annuities.
Deferred Fixed Annuity vs. Immediate Fixed Annuity
The two primary types of fixed annuity are deferred fixed annuities and immediate fixed annuities.
Almost all of your annuities will fall into one of these two categories. The distinction here is in regards to the timeframe of pay-ins and payouts to the annuity account.
Deferred fixed annuities are designed to defer payments to the beneficiary of the account until a later date in time.
This can be established to allow sufficient funding, or may just be designed to postpone funds until they are needed.
The period is established at the start of the contract and may be for any number of periods.
Immediate fixed annuities are designed to start payments one period after the account is funded.
If the payments from the account are going to be made to the beneficiary on a monthly basis, then the account will start paying out one month after the creation of the account.
If it is a yearly annuity, then the payments will be made one year after the account is created.
Types of Fixed Annuities
There are a number of different types of fixed annuities, each with their own particular stipulations and behaviors.
The fixed annuity type that will work best for your situation will depend on a number of different criteria.
Before you make an decisions regarding buying fixed annuities, you should be sure that you have sufficiently researched the various types of annuity products.
We’ve thrown together a short list of some the different types, names, and variations of fixed annuities below.
This list is by no means comprehensive, but is intended to give you some idea of the extent of different annuity types.
Fixed annuity types:
- Fixed Income Annuity
- Fixed Index Annuity
- Deferred Fixed Annuity
- Immediate Fixed Annuity
- Fixed Term Annuity
- Fixed Life Annuity
- Fixed Rate Annuities
- Fixed Period Annuity
- Fixed Equity Annuity
- Annuity Certain
- Cash Refund Annuities
- Equity-Indexed Annuities
- Installment Refund
- Joint and Survivor Annuity
- Joint Annuity
- Life Annuity Certain
- Modified Cash Refund Annuity
- Pure Annuities
- Refund Annuity
- Temporary Life Annuities
As you can see, the forms and variations of fixed annuities come in all different varieties.
It is strongly advised that you get a qualified financial advisor to help you determine which if any of these products would work for your circumstances.
How do you Determine Suitability for Annuities?
An important factor in determining what are the best fixed annuities for you is the suitability of the product your circumstances and your specific financial needs.
Factors that may influence the fixed annuity suitability are age, risk tolerance, size of the annuity, net worth, liquid assets, etc.
The important thing to remember is that you want to find an insurance product that does not jeopardize your savings, your retirement, or your safety.
What are the Fixed Annuity Pros and Cons?
As with any financial product, there are some clear and distinct pros and cons and there are some more subtle distinctions.
Let’s focus for a moment on the more obvious pros and cons of fixed annuities.
One of the primary reasons for the purchase of a fixed annuity is to provide the annuity owner a safe and predictable income stream.
One of the advantages of this type of annuity is that you are able to purchase the annuity to make payments to the designated beneficiary that will last for the remainder of the annuitant’s life.
This allows the investor to plan for a fixed income stream that will last them until they die. This can add a welcome degree of certainty to what can be an uncertain future.
Some may also find the tax treatment of the annuities to be one of the major advantages of fixed annuities.
The main complaint that most investors have about fixed annuity products is that they are notoriously hard to get your money out if you choose to terminate the contract.
Fixed annuity surrender charges can be quite atrocious.
The insurance companies have created what they consider to be an appealing product that allows you payments for life.
In order to protect the returns of their investors, they penalize the early withdrawals of funds from your account.
For this reason, fixed annuities are considered to be rather illiquid assets.
Another common complaint is that fixed annuity rates tend to be lower than other investment types. As with everything else, you are trading safety for returns.
If you want higher returns, you need to trade back some of the safety you have negotiated.
Fixed Annuity Taxation
As stated above, fixed annuity taxes can be considered one of the primary advantages of fixed annuities.
A typical annuity is separated into two phases, the accumulation phase and the liquidation phase.
During the accumulation phase, the account owner adds funds the account and allows the account to grow. During this period of time the account grows tax-deferred.
During the liquidation phase is when your tax liability comes into play.
Distributions from fixed annuities are taxable to the beneficiary to the point that applicable exclusions have already been determined.
Only a portion of each year’s payments are taxable. A certain exclusion ratio is used to determine what portion of the annuity was already been taxed, and which portion is liable to the IRS.
Once the exclusions have been exhausted, then the entire portion of the annuity payment becomes taxable upon receipt.
Risks of Fixed Annuities
One of the primary fixed annuity risks is that of inflation.
One of the inherent risks you run when you equate a fixed payment over the course of a period or for the lifetime of the annuitant is that the value of the dollar amount you are receiving degrades.
Your purchasing power is an important part of your future well-being and should determine whether or not you live the lifestyle that you are hoping during your retirement.
Another risk is that of opportunity cost.
Because of how difficult (let’s call it cost-ineffective) it is to take money out of your annuity before it is intended, you may pass up on opportunities that arise to invest your money elsewhere.
As far as product performance or the insurance company stability, the risk is not overly high.
The insurance industry is managed at the state level. Because of this, they have built in safeguards to their policyholders.
If an insurance company were to go under, the insurance industry would pick up the existing policies and move them to subsequent companies.
You will have much more product performance risk with a variable annuity product vs fixed annuities.
What Companies Offer Fixed Annuities?
To find a fixed annuity company is actually quite simple. Most major insurance companies will have a line of annuity products.
Where the fixed annuity is the simplest form of this product, you will have little difficulty finding a company that carries fixed annuity products.
The best way to get a fixed annuity quote is to speak with a financial advisor or broker that is licensed with a number of different insurance companies.
They will have done the sufficient research to help you determine what the best policy is for your needs.
Of all the fixed annuity information that they have gathered, they should be able to help you piece together a product that works for your circumstances and fits your suitability needs.
Don’t be afraid of fixed annuities, they aren’t as bad as everyone warns.
It is true that you need to adequately understand the financial product before you jump into purchasing it.
The fixed annuity is a long-term investment and should only be made after careful consideration of all of the pros and cons of the product. Only you and your advisor can determine if this is right for you.