Last Updated: July 2020
Fixed annuities have a lot to offer and can be extremely beneficial towards your retirement, depending on your unique circumstances.
While some annuities have more aspects that are less predictable but can offer more potential gain, others are meant to be more reliable, predictable, and an investment you can depend on for your retirement years.
A fixed income annuity certainly falls into the class of predictability. It can help seniors create a stream of income during some of the tightest financial years of their life.
The rest of this quick article is designed to break down and make the fixed annuity easy to understand by breaking down the pros and cons in addition to providing a more in-depth analysis of this investment option.
Here is what will be covered:
- Fixed Income Annuities Overview
- The Pros of Fixed Income Annuities
- The Cons of Fixed Income Annuities
- What Other Options Do You Have?
- How Can I Begin Shopping for Fixed Income Annuities?
- Final Thoughts
Fixed Income Annuities Overview
Fixed-income annuities are often purchased by individuals that are more risk-averse and prefer a guaranteed percentage of earnings on their retirement or savings.
Most commonly, fixed annuities are purchased by offering a large lump sum of cash in exchange for a guaranteed interest rate of return on your investment that will be paid periodically that you select when you enter the contract.
Examples can include monthly, quarterly, semi-annually, or annually.
After your initial investment, unless you choose an immediate annuity (more on this later), your money will begin what is referred to as the accumulation period.
The accumulation period is nothing more than the time your annuity spends gaining additional principal and compound interest by taking your initial investment and earning your fixed interest rate, which will commonly fall between 2-4% in the current market.
Fixed annuities are considered the most basic and easy to understand form of annuity you can purchase.
Especially compared to other options such as variable annuities.
The Pros of Fixed Income Annuities
The pros of fixed annuities are relatively straightforward.
Easy to Understand
Investments are not always easy to wrap your head around.
Often, it is difficult to understand how our investment will protect us if certain situations arise and what exactly we are benefiting when investments have complex fees and additional features.
With fixed annuities, it is an entirely different story.
There is no fancy math taking place with a fixed annuity that needs to be completed.
You put your lump sum of money you have (most typically a savings or a rollover from an IRA or retirement fund) into the annuity.
In exchange, the life insurance company will offer you a fixed percentage/interest rate for a specific period.
This could look something like the following:
100,000.00 lump sum money is invested and given to the insurance provider
The insurance provider pays you a 3.00% interest on your annuity for 20 years with the withdrawal of 5,000.00 per year if or 416 per month.
This allows you to collect your 3.00% interest while drawing your lump sum of cash monthly to meet expenses.
It should be noted, the above example is 100% only an example and not based on any real numbers or current annuity rates.
It is in no form an actual payout structure from any specific company.
Annuities Make You Feel Safe and Are Predictable
One of the most sought after benefits of annuities is that they can allow you to sleep at night knowing that you can’t lose your initial principal and can give you the comfort that they are least earning some form of interest during the accumulation phase and the payout phase.
The interest rate you will be earning on a fixed annuity is set in stone before the contract is ever signed and guaranteed.
It is a simple exchange for cash from your nest egg for the ability to monthly stream income while earning interest without dozens of different fees involved.
It is black and white, easy to comprehend, and a safe way to safeguard retirement assets while still earning some extra money during the process.
Risk is Extremely Low with Fixed Annuities
The last significant benefit of choosing a fixed annuity is the peace of mind that comes with it.
Virtually no risk is involved with purchasing a fixed annuity.
The interest rate that you set at the beginning of the contract is not based on anything except the guarantee provided and the contract you enter when purchasing your annuity.
You have no market performance to worry about, which has always been an ideal and recommended way for seniors living on a fixed income to invest and safeguard the limited funds they have remaining to get the safest and most guaranteed streams of income possible.
With all the benefits we discussed a moment ago, it should also be noted that fixed annuities do not come up without some drawbacks that need to be considered as well.
Here is a quick look at those.
The Cons of Fixed Income Annuities
Struggling Ability to Keep Pace with Inflation
Although fixed annuities can easily be deemed safe and like the best approach to retire with peace of mind, you do begin running into an entirely new problem.
At 2-4% returns on your annuity, your investment is not going to do well with winning the race against inflation.
It is projected that inflation will be 2.27% in 2021, according to Statista.
Clearly, if this is the case, you would have to find an annuity that is paying the best rates available to out-run the ever-rising cost of living.
To get up to speed at options capable of doing this, be sure to read our article breaking down the highest paying fixed annuities here.
Boring and Nothing to Get Excited About
Anytime you have something with no risk involved, it is rare that you have a chance at a high reward.
This is especially true with fixed annuities.
While you can feel great about knowing that your investment is protected, you also have to live with the fact that you will never see more than that flat interest rate you agreed upon when you initially started your annuity.
It is one rate for the duration of the annuity.
Nothing more and nothing less.
Deferred Taxes is Great, Taxed at Ordinary Income Is Not So Great
There is no denying that it is a benefit to be able to defer your earnings until the later years of your investment.
However, do not get too excited just yet.
When you do begin pulling your annuity withdrawals and taking your supplement incomes, your earnings will be taxed each year as ordinary income.
This is typically a harder tax hit as opposed to being hit for taxes on capital gains.
Ensure You Have the Cash, Surrender Fees Can Hurt
A pitfall to always avoid when purchasing any kind of annuity is strapping yourself too tight on funds.
When doing this, you are setting yourself up to need access to quick cash, and if that does happen with an annuity, you are going to be paying some hefty surrender charges.
Ensure you work with a reliable and trustworthy financial professional and ensure you have the living capital, emergency funds, and the liquidity to use your cash towards an annuity and forget about it and allow it to begin compounding interest.
What Other Options Do You Have?
You always have other options you can consider for your retirement planning outside of a fixed annuity.
Sticking within the annuity investing arena, you can also chase more gains and take more risks by choosing a variable annuity.
Variable annuities are known to have higher fees and have more risk of principal loss inside of the investment account but also provide the opportunity to earn a higher percentage than your typical 2-4%.
For other options, it is best to speak to a licensed financial professional who can look at your entire portfolio, current needs, and help you plan for a secure and enjoyable retirement.
How Can I Begin Shopping for Fixed Income Annuities?
Annuity rates are frequently changing and are subject to change at any time.
The rates are set by insurance companies.
This makes it imperative to ensure you are checking the rates frequently and with a large handful of companies to ensure you are locking yourself into the best interest rates possible.
When you begin your search, stick with trusted life insurance providers that have strong financial strength ratings and a good track record.
Annuities can serve as a valuable tool for any retirement plan.
It is even more beneficial that you can provide yourself with mediocre returns without the concerns of risk involved.
With the world rapidly changing, and it becoming more difficult to plan, annuities are still a great way to earn interest and have some certainty built into our retirement years.
Best of luck in your search.