The fixed annuity is an insurance contract between an annuitant and an insurance company. The insurance company agrees to pay the annuitant a fixed income for a period of time based upon the value invested in the annuity. For this reason fixed annuities are also referred to as fixed income annuities.
There are numerous types of fixed annuities, ranging from payments for a set period of time to payments that are dependent on the life span of an individual. The type of the fixed annuity depends entirely on the structure needed for the individual.
Fixed annuities are often misunderstood by investors, and as a result carry a certain degree of uncertainty. Many people ask themselves: how do annuities work? In order to successfully and prudently utilize annuities one must form in their mind at least a general understanding of how exactly do annuities work. As with other assets, it is important to fully educate yourself regarding annuities before making a decision. It is important to seek the advice of a qualified professional. Individual circumstance warrant different approaches.
What Are The Different Types of Fixed Annuities?
Unfortunately one cannot simply ask: how do annuities work? Because the answer really depends on the different types of fixed annuities you are interested in (on this website we opt to ignore variable annuities and focus on fixed annuities, hence the site name). Despite the many different types of fixed income annuities, fixed annuities will always fall under one of two categories: deferred or immediate.
This concept is pretty straightforward. For an immediate annuity, the first payment from the insurance company is due one payment interval from the date of purchase. If the payment will be paid out monthly, then payments start one month after purchase of the contract. Yearly payouts begin one year after first payment. A deferred annuity requires the fixed annuity to be purchased over a period longer than just one payment.
Other types of fixed annuities include: annuity certain, life annuity, joint annuity, joint and survivor annuity, life annuity certain, and a more complex variation such as the equity-indexed annuity. The differences between these types of fixed annuities are found in the duration of payouts, the designated life on the contract, payment certainty, and bonus stipulations.
What are the Advantages of a Fixed Annuity?
One of the more appealing aspects of a fixed annuity is that it pays a fixed dollar amount for the duration of the contract. This can be a particularly appealing feature in times of market volatility (something pretty common these days). The fixed annuity behaves similar to a CD*, and provides a guaranteed payment for the duration of the payout period.
**Bank certificates of deposit are FDIC insured up to applicable limits and offer a fixed rate of return.
Some types of fixed annuities, such as the equity-indexed annuity, can actually pay a minimum interest rate in market downturns, and then can provide additional interest during the market’s up years. This can be an effective way to help protect the principal of your investment, and still potentially participate in market upswings. The stipulation with this type of annuity is that it is subject to caps and/ or participation rates. This more or less just means that you can only “participate” in a portion of the market growth, or that the growth is “capped.” It is important to note that you are not investing directly into the market or index.
Another appealing attribute of fixed income annuities is the ability to provide income for the duration of an individual's life. A lifetime annuity gives retirees a fixed income that they will not outlive. This can be a powerful tool to provide additional security during retirement.
What are the Disadvantages of Fixed Annuities?
As with any asset, there are both pros and cons to the financial vehicle. This is very much the case with fixed annuities. While the fixed annuity can provide a definite and recurring stream of income, it can also come with steep penalties if you change your mind. Most annuity contracts have sharp surrender penalties if you attempt to get your money out faster than the predetermined rate. This also makes the contract rather illiquid.
Another weakness of many fixed annuity products is that they generally do not adjust for inflation well. Fixed rate annuities with life income may gradually lose their purchasing power over time. Not all fixed annuity products have this problem, and simply understanding that this can happen can allow you to implement strategies to combat this problem. Many weaknesses of financial products can be overcome with comprehensive financial planning.
Fixed Annuity Summary
The fixed annuity can be a very useful financial planning tool, particularly in retirement planning. Individuals looking for a steady and guaranteed income will find the fixed annuity to be particularly effective. As with all financial planning, it is very important to understand the facts before purchasing or investing. Fixed annuities are not for everyone. Purchasing a fixed income annuity should only be undertaken after careful consideration.
Contact us for more information regarding whether or not a fixed annuity may be right for you.
All guarantees are based on the financial strength and claims paying ability of the issuing insurance company, who is solely responsible for all obligations.
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