How Does a Fixed Annuity Work and What Are the Benefits?
Like general annuities, a fixed annuity provides guaranteed income for people heading into retirement. The annuity is also a contract—with variables. And that can make choosing the right one challenging.
Take Jackson, for example. He’s in his early fifties. His mother passed away several months ago, leaving him an inheritance.
He wants to invest the money as soon as possible. Jackson hears about fixed annuities for building retirement income.
He sifts through online articles but finds it difficult to sort out the details.
Jackson talks to his retirement specialist who explains how a fixed annuity works and the benefits of investing in one.
What is a fixed annuity?
A fixed annuity is similar to a certificate of deposit (CD). Unlike a bank-issued CD, an insurance company controls the fixed annuity. That includes guaranteeing the interest and payments to the investor.
But Jackson discovers that fixed annuities can be tricky to understand.
For example, the term “fixed” implies that the annuity is unchanging—set in stone. That’s not quite the case. The interest rate may change, depending on how the insurance company draws up the contract.
It could be that the annuity’s interest rate stays at a fixed rate for a period of time. But the contract may state that the interest will change at certain times according to the current rates.
Also, fixed annuities come in two types: deferred and immediate.
Deferred fixed annuity
As the name suggests, a deferred fixed annuity guarantees an amount of tax-deferred interest. That means, the interest won’t be taxed until you withdraw money from the annuity.
Additionally, with a deferred annuity, you can roll over IRA money, as well as other types of funds. If you put your IRA money into a deferred annuity, the IRA tax rules will still apply.
For Jackson, he can put his inheritance in a deferred annuity, but if he needs to access the money prior to age 59 ½, he will pay income taxes, and he may incur penalties.
Immediate fixed annuity
An immediate fixed annuity is a good fit if you have a lump sum of money to invest and want to receive income right away.
With an immediate annuity, also called a single premium immediate annuity (SPIA), you know what the payments will be—for life. That said, there are some immediate annuities that adjust for inflation (an option to discuss with your retirement specialist).
An immediate annuity may be a good fit for Jackson, as he can choose payment terms, ranging from a payment over a decade to receiving guaranteed income for life.
Ultimately, a fixed annuity may be a good fit if:
- You are risk averse
If you’re looking for an investment that guarantees income payments for life and is not subject to market changes, a fixed annuity is a good option.
However, talk to your retirement specialist about how the interest rates are written into the contract: some contracts will include rate changes (this is where a fixed annuity can get tricky).
- You have time
If you still have plenty of time before retirement, investing your lump sum of money now in a fixed annuity might be a good fit. The deferred taxes will allow your investment to earn compound interest over the years. And taxes will only kick in once you’re ready to withdraw funds.
- You’d like to receive payments now
If you have a sum of money you’d like to invest and start receiving a stream of income now, an immediate fixed annuity may be a good option. You can decide which terms will work best for you—such as receiving payments for the next ten years or over your lifetime.
Sorting out the details
At first glance, fixed annuities seem straightforward: you hand over a sum of money and the insurance company guarantees income for life. But there are different types of fixed annuities with contract details that affect when you receive the payments, for how long and at what interest rate.
Talking to someone who can explain everything about fixed annuities—from fees to surrender charges—will help you tailor a fixed annuity to best fit your needs.
Are you thinking about investing in an fixed annuity? Aaron, MSHP’s retirement plan specialist, can answer your annuity questions.
Click here for a free consultation.
