A retirement savings plan, such as a fixed annuity with a guaranteed rate of return, is a great supplement to other forms of retirement income. In addition, fixed annuities are a popular investment vehicle because they are fairly safe and reliable.
Having noted that, fixed annuities have a downside. While fixed annuities can be a good investment, they are not the best choice for everyone.
We will explain how a fixed annuity works, the benefits you can expect if you invest in one, and why it may or may not be your best choice.
How Does a Fixed Annuity Work?
Traditional fixed annuities are insurance contracts that have a guaranteed rate. You can purchase fixed annuities either by making payments over time or simply making a lump sum payment.
The initial phase of a fixed annuity is called the accumulation phase. During this phase, the insurance company guarantees the account will earn a certain rate of interest.
When an annuity owner decides to start receiving payments from the account, the insurance company will calculate the amount of the payments and the length of time the payments will continue.
The payout phase begins once the annuity owner requests payments from the account. The payments will continue either for a certain number of years or the remainder of the annuity owner’s life, depending on the terms of the contract.
What Are the Benefits of a Fixed Annuity?
When considering purchasing a fixed annuity, it is important to consider the pros and cons. A fixed annuity carries several valuable benefits for recipients and just a few cons.
Protects Against the Risk of Market Losses
Insurance companies invest the premium payments for fixed annuities primarily in government bonds and high-quality corporate bonds. Whether the insurance company makes money or loses it, they are responsible for paying annuity owners as promised in their annuity contracts.
By contrast, the annuity owner has control over the investments in a variable life annuity, and they may gain or lose money along the way.
Minimum Rates Are Guaranteed
Fixed annuities have an initial guarantee period where the annuity owner receives a specified rate of return. When the initial guaranteed period ends, the insurance company can modify the rate based on a certain formula or the earnings in the investment portfolio. Fixed annuity contracts specify a minimum rate guarantee after the initial period.
Fixed annuities grow on a tax-deferred basis. The money is only taxed when an annuity owner withdraws money from the account, whether that occurs as a withdrawal or as regular income payments. Tax deferrals can make a huge difference in the growth of a fixed annuity, especially for people in higher tax brackets.
Any time the annuity owner chooses, they can convert a fixed annuity into an immediate annuity. At that point, the annuity account will begin making guaranteed income payments either for the time listed in the annuity contract or for the life of the annuity owner. There is no concern about losing money.
Principal Is Relatively Safe
While bank accounts are federally insured, annuities are not. Nonetheless, fixed annuities are considered relatively safe as long as annuity owners do business with life insurance companies that have solid financial ratings from independent rating agencies.
Fixed annuities may also offer a death benefit as part of the contract. If the annuity owner passes away before the annuity begins to pay out, the beneficiaries will receive the payments.
What Are the Cons of a Fixed Annuity?
The main downside of fixed and variable annuities is there is little flexibility in using the funds before regular payments begin.
Owners of fixed annuities may usually take one withdrawal per year of approximately 10% of the account value once the surrender period ends. In some cases, annuity owners must pay a surrender charge for withdrawing money from the account.
Guaranteed fixed annuities can carry high fees compared with other types of investments.
Moreover, annuity owners aged 59½ and younger may be subject to a tax penalty in addition to the regular income taxes they must pay on the income.
Investors who need money for a sudden financial emergency may be unable to access enough funds from a fixed annuity for their needs.
Lastly, because guaranteed fixed annuities pay a fixed sum, annuity owners will not benefit from gains in the market when the market is trending positively.
How Are Fixed Annuities Taxed?
Fixed annuities that are held in qualified retirement plans are called qualified annuities. With this type of annuity, the government does not tax funds until the annuity owner withdraws them.
Conversely, a non-qualified annuity grows on a tax-deferred basis during the accumulation phase. The annuity owner begins taking payments, and a percentage of the money is then taxed.
A fixed annuity is a good choice for anyone who wants a safe, guaranteed source of income. It is not for the individual who hopes to make great gains in the stock market during retirement.
Terms vary greatly for fixed annuities, so it always pays to shop around. If you are considering a fixed annuity, give Leap Carpenter Kemps a call today at 209-384-0727, and one of our agents will guide you in the right direction.
As the Employee Benefit’s Department Manager at Leap | Carpenter | Kemps Insurance Agency, I use my 20 years of insurance expertise and background in Human Resources Management to find the best policies for both business owners and their employees.
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Leap | Carpenter | Kemps Insurance Agency provides Commercial Business Insurance, Employee Benefits, Life and Health Insurance, and Personal Insurance to all of California, including Merced, Atwater, Los Banos, Mariposa, Madera, Fresno, Modesto, Turlock, and Stockton.
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