What Is a Fixed Annuity?
A fixed annuity is a financial contract that guarantees a rate of interest on any money deposited into the annuity account. This annuity type accrues interest over time on a tax-deferred basis, and provides a consistent income stream.
Unlike variable annuities that provide inconsistent payout amounts based on a fluctuating financial market, a fixed annuity ensures the amount an annuity owner, or annuitant, receives is consistent. This investment tool is considered low risk because there is a set interest rate unaffected by the performance of outside investments like mutual funds, stocks and bonds.
How Do Fixed Annuities Work?
Fixed annuities guarantee a rate of return for the duration of the contract, and a steady income stream for the remainder of your life or for a set period of time.
After paying for the principal using a lump sum or monthly premium payments, the principal will grow tax-deferred during the accumulation phase of the contract. This amount plus interest will later be disbursed as regular monthly, quarterly or annual payments.
Fixed annuity assets are not taxed until withdrawn from the account. If over the age of 59 ½ years old, annuitants can make withdrawals of up to 10 percent of the annuity account value without penalty. If under the age of 59 ½, early withdrawals will be subject to a 10 percent IRS penalty.
Fixed annuity disbursements can be deferred or immediate. In a fixed deferred annuity, the payout is disbursed later in life and allows for the investment to accrue interest until the distribution phase. A fixed immediate annuity disburses income immediately after purchase for a set period of time.
Annuitants can also choose to elect a death benefit within their fixed annuity contract. In the event the annuitant dies before all assets have been disbursed, all remaining investments can be transferred to a spouse or other beneficiary. The beneficiary will also inherit all taxes owed on the remaining funds.
Fixed Annuity Types: Life vs. Term Certain
There are two main types of fixed annuities: life annuities and term certain annuities. While both options provide a guaranteed payout, they differ in how long the distribution phase lasts.
Term certain annuities disburse a set amount of income through a specified date. However, this annuity option does not account for the annuitant’s current health condition or life expectancy. If the annuitant dies before the end of the set term, all remaining assets are surrendered to the insurance company. If the term ends before the annuitant’s death, all disbursement will end.
Life annuities, on the other hand, provide a set amount of income until the annuity owner dies. If an annuitant dies before receiving the entire value of their annuity investment, they risk losing the remainder of their principal if a beneficiary is not selected. There are two primary life annuity options:
- Single-Life Annuity – This annuity option guarantees a payout until an annuitant’s death. It is only valid for one person, and typically offers a higher payout rate than a joint-life contract.
- Joint-Life Annuity – If annuity owners are looking to secure their financial futures and those of their spouses, they may elect a joint-life annuity. This annuity option ensures that if an annuity owner dies before all assets have been disbursed, the surviving spouse or beneficiary will receive the income until their death.