Fixed annuities are interest-based retirement investment options, offered by insurance companies that require a single premium, just one up-front payment. A fixed annuity uses one of two distribution models: immediate or deferred. Immediate fixed annuities start issuing monthly payments right away, until the initial premium plus interest gets paid out. Deferred annuities don’t pay out until the end of their term, compounding interest like a typical retirement savings account. In general, most fixed annuities contain the following features:
- Guaranteed Rate of Return
- Tax Deferral
- Secure Principle
- Option for Lifetime Income
- Bailout Provision
- Penalty-free Withdrawal Provisions
Although all of these points are important, the most appealing feature of fixed annuities is their stable interest rate. While markets can go up and down, fixed annuities remain stable with a guaranteed 3-10% interest rate, for a period of 3 to 15 years. This aspect is what makes them the most popular annuity, comprising over 75% of all annuities sold. They are ideal for retirement planning because with a fixed rate, investors know exactly how much money they will have at the end of the term. Other investment options such as CDs, bonds, and treasury bills offer this same security, but often at lower interest rates and without the tax-deferral advantage.
All annuities are tax-deferred and also offer the benefit of lifetime income. Fixed annuities are one of the few investment options that guarantee a zero loss of principle. Unless the insurance carrier goes completely out of business, the absolute worst-case scenario is a lower-than-expected return. This is a key point because while it does not make fixed annuities totally risk-free, it does make them an extremely attractive investment option for retirees.
The other extremely attractive feature of fixed annuities is the option for lifetime income. This provision is probably the most appealing aspect of all annuities. With a lifetime optioned annuity, once reaching the age of 59 ½ the annuity holder can then begin receiving regular disbursements. The frequency and amount of these disbursements will vary depending on the annuity contract. Depending on the terms of the contract, disbursements to the holder may be made monthly, quarterly, semi-annually, or annually. Thus, it is possible that the holder may not receive their first payment for up to a year after purchasing an immediate annuity.
Fixed annuities usually come with a limited period of guarantee, for example a fixed interest rate of 6% for the first 3 years of a 5-year investment term. In order to protect the investor against a serious interest rate collapse during the rest of the contract term, a bailout provision is included in the contract. If the interest rate that kicks in after the guarantee period expires is more than a 1% drop, then the annuity holder has the option to cash-out with no penalty. The annuity can be liquidated and then invested into another, more competitive annuity or something completely different.