In an age where financial uncertainty is the norm, retirees face numerous concerns regarding their retirement income strategy. Transitioning from saving money for retirement (the accumulation phase) to relying on savings for income (the distribution phase) may be daunting for many. This is where fixed annuities come into play as a potential solution.
What is a Fixed Annuity?
A fixed annuity, also known as a fixed-term annuity or multi-year guaranteed annuity (MYGA), is a contract with an insurance company. Fixed annuities earn a fixed interest rate on an initial premium(s); the interest rate applied to the annuity is guaranteed, offering predictable growth.
Fixed annuities are primarily used as a financial tool designed to hold your money for a specific time period while it earns interest. While the terms are usually between 3-5 years, longer terms may be available depending on your contract.
Fixed annuities can be categorized into two primary types: tax-deferred annuities and immediate annuities. Deferred annuities allow your money to enjoy tax-deferred growth until you start taking withdrawals. Immediate annuities start paying you income within 12 months of your purchase.
Like any financial product, the devil is in the details for fixed annuities. Understanding the nuances of payout options, interest rates, and contract terms is important for making informed decisions about your retirement security.
How Do Fixed Annuities Work?
As with other types of annuities, there are two phases in a fixed annuity’s lifecycle: the accumulation phase and the payout, or distribution phase. During the accumulation phase, a deposit is made to an insurance company. The insurance company, in turn, credits the annuity with a guaranteed interest rate, as specified in the annuity contract.
Determining Your Fixed Rate
The interest rate in your contract is what will largely determine your eventual income payments. However, there are multiple rate types in play, each of which can impact payout amounts. Make sure you understand each facet of your fixed rate to maximize the effectiveness of your annuity.
- Declared interest rate: This is the rate the insurance company sets periodically and guarantees for a limited time. It may change upon renewal, so keep an eye out for updates.
- Minimum guaranteed rate: This is the absolute lowest your interest rate may go, as outlined in the contract. It is a failsafe against drastic interest rate drops in the economy.
Choosing Between Payout Options
When you’re ready to turn your annuity into income, you’ll enter the distribution phase. This is also called annuitization. You’ll have to decide at that time how long you want to receive income:
- Lifetime income: The classic option. You receive payments for as long as you live, guaranteeing you won’t outlive your income stream. This may be a single life annuity (just for you) or a joint life annuity (covering you and a spouse). The amount you receive in lifetime income will be based on your annuity’s account value at the time of annuitization, plus your life expectancy as determined by the insurance company based on age and gender.
- Period certain: Payments are guaranteed for a set number of years (like 10 or 20). If you pass away before the period ends, your chosen beneficiary receives the remaining payments.
- Combination plans: These offer a balance between lifetime income and guaranteed payments for a specific period. For example, you might receive lifetime payments, but with a guarantee of payments for at least 20 years. If you pass away before the 20-year period ends, your named beneficiaries will receive a benefit equal to the amount of payments remaining.
NOTE: All guarantees are subject to the claims-paying ability of the insurer.
Benefits of Fixed Annuities
There are several benefits to buying a fixed annuity, including:
- Simplicity: Fixed annuities are easier to understand than other annuity products. There are no complex matrices to understand or charts to interpret. You know exactly how much you will receive and when.
- Tax advantages: Fixed annuities grow tax-deferred, meaning you won’t owe taxes on what your annuity earns until you begin taking withdrawals. Some qualified annuities also enable you to make pre-tax contributions from a qualified retirement account.
- Inflation hedging: Some fixed annuities may be set up with an increasing payment structure to help offset the effects of inflation on your retirement.
- Flexibility: You can choose the frequency of your income payments—monthly, quarterly, or annually—and whether you want income for life or a set period.
- Risk management: By providing a guaranteed income stream, fixed annuities help you manage the risk that more volatile investments in your portfolio might not perform as well as expected.
- Supplemental income: Fixed annuities often act as additional income, supplementing what you receive from Social Security and other retirement accounts like 401(k)s and traditional IRAs. If you consult with your securities advisor, you may find that the consistent cash flow offered with some fixed annuities may allow other investments to be used for discretionary spending or left to accumulate further.
- Death benefits: Most fixed annuities offer death benefits, which means that your beneficiaries may receive a payout if you die before taking the total amount of your money out of the annuity.
Considerations for Fixed Annuities
When investing in a fixed annuity, you’ll want to note any surrender penalties outlined in your contract. Deferred annuities require you to hold money in the annuity for a specified period, called the surrender period. Most contracts include specific ways to access some of your funds during this period. For example, many fixed annuities allow you to withdraw up to 10% of the annuity’s value per year, penalty-free. There are also no fees to your beneficiary if you pass away, and no fees for withdrawals once the surrender period ends.
However, withdrawing excess funds from your annuity before the conclusion of the surrender period could result in a surrender charge. The insurance company levies this fee to offset its initial expenses.
Who Should Consider Investing in Fixed-Interest Annuities?
While the reliability of fixed annuities can make them an attractive choice, they aren’t right for everyone. For example, younger professionals who want to start planning for retirement may wish to explore indexed annuities over fixed annuities, since they want their funds to grow at a higher rate over a longer time.
Fixed annuities may be a good retirement savings option for those who:
- Are nearing retirement age or are already retired: Protecting your nest egg against market fluctuations becomes a priority as you transition into retirement.
- Need a guaranteed income base: Fixed annuities may work well alongside other income sources, such as Social Security or pensions, providing that extra level of security.
- Are conservative with a portion of their portfolio: For those who want to lock in a certain level of income while still maintaining some exposure to growth-oriented products, a fixed annuity may be part of a balanced approach.
How to Choose a Fixed Annuity
If you are considering purchasing a fixed annuity, it is important to research and choose an annuity that is right for you.
First and foremost, you’ll want to choose your insurer wisely. Just like you want a robust and reliable bank, you want the same from your insurance company. Your guaranteed payouts depend on the insurance company’s financial health, so look for well-respected companies with good financial ratings.
Here are a few more factors to consider when choosing between fixed annuity products:
- Interest rate: Compare interest rates from different insurance companies to ensure you’re getting the highest potential for growth.
- Surrender charges: Surrender charges are fees you may have to pay if you withdraw your money before the surrender period ends. Be sure to understand the surrender charges before you purchase an annuity.
- Rider Options: These are like add-ons. Some may enhance your contract (e.g., guaranteed minimum income benefit), while others help protect your legacy (e.g. death benefits). However, they often come with additional fees and are subject to availability.
Most contracts have a window (usually 30 days) during which you may change your mind and receive a full refund. This is called a free look period; it offers additional time to scrutinize the terms and ask questions before your annuity is locked in place.
The Role of Fixed Annuities in a Modern Retirement Strategy
In a retirement strategy, where uncertainty is the only certainty, fixed annuities offer a counterbalance. For those looking to stabilize their retirement finances, a fixed annuity may serve as a foundational piece, ensuring steady income regardless of external conditions. They aren’t for everyone, but for those who value predictability and peace of mind, they can be an excellent choice.
As with any financial product, it’s important to understand the terms, benefits, and potential downsides of fixed annuities. A licensed agent can help you gain clarity on whether a fixed annuity aligns with your retirement goals and risk tolerance, and help you compare product offerings to find the right fit.
To see if a fixed annuity is right for you, contact one of our licensed experts today.
