If your traditional Certificate of Deposit is ready to mature, a fixed annuity could be great option for you. In today’s economic environment, fixed annuities can offer compound growth without the anxiety associated with stock market volatility. In addition to safety, other fixed annuity advantages can include attractive yields, tax efficiency, and liquidity.

What is a fixed annuity?

Interest rate and principal guaranteed: A fixed annuity is an annuity wherein the issuer (usually an insurance company) guarantees both the interest rate paid on invested dollars and the return of principal. The issuer guarantees that a minimum rate of interest will be paid on the annuity, but the actual rate of interest credited to the annuity is typically higher than the guaranteed rate. All of the premium payments that you make to the issuer will then compound (tax deferred) at least at this guaranteed rate of return, subject to the claims-paying ability of the annuity issuer.

Distribution payouts are fixed: The second part of a fixed annuity that is “fixed” is the amount of benefit that will eventually be paid out to you during the distribution period (provided you elect to annuitize the annuity). Once the distribution period begins and you select your settlement option, the annuity distribution to you will be the same each month (or other time period that you select).

Offers a guaranteed minimum interest rate: The issuer of a fixed annuity guarantees that a minimum rate of interest will be paid for the life of the annuity. However, the annuity issuer will usually pay a higher rate of interest than the minimum guaranteed rate. The annuity issuer will typically pay a higher rate of interest on the annuity during the first year to induce people to purchase the annuity. The issuer will then usually adjust the interest rate in the following years to correspond with the ups and downs of the interest rate environment. When interest rates rise on other money market instruments or certificates of deposit, the annuity issuer will likewise increase or decrease the interest rate it pays on the annuity. However, the issuer cannot pay less than the guaranteed minimum rate without being in default.

Interest rates may be low on fixed annuities: Interest rates paid on fixed annuities are subject to the current interest rate environment. During periods of low interest rates (some periods can go on for many years), the interest rates for an annuity can be low and remain low for quite some time. Low interest rates could impact the potential growth of your annuity. However low the interest rate environment goes, the annuity cannot pay less than its guaranteed minimum rate.

When should you buy a fixed annuity?

Want to save money tax deferred: A fixed annuity may be an excellent vehicle for individuals who want the benefits of tax-deferred earnings. The earnings on a fixed annuity (as with other types of annuities) are not subject to income tax until they are distributed. Thus, your annuity premiums and earnings may compound tax deferred for many years.

  • Tanya purchases a fixed annuity from an insurance company with a guaranteed interest rate of 4 percent. For the first year, the insurance company pays interest of 6.5 percent on the annuity. Tanya plans to hold this annuity for 20 years. All of the interest that accrues on this annuity will be tax deferred. Tanya will not have to pay any taxes on the interest until she begins to withdraw money from the annuity. By that time, Tanya may be in a lower income tax bracket. (This example is for illustration purposes only and does not reflect a particular investment or product).

Want a guaranteed fixed rate of interest on investments: A fixed annuity may also be a good investment for an individual who is a conservative investor. Because the annuity issuer promises to pay you a minimum rate of interest on the money invested in the annuity, there is little downside risk to a fixed annuity. With a fixed annuity, you know right at the beginning the minimum rate of return you may earn on your fixed annuity. Usually, the annuity issuer will pay a higher rate of interest than the minimum rate, but it will never pay less than the guaranteed amount. Guarantees are subject to the claims-paying ability of the annuity issuer.

Fixed annuity may be good supplement to qualified retirement plan: You may also want to purchase a fixed annuity if you would like to put more money toward your retirement than what you have already contributed to your qualified retirement plans. If you are saving for your retirement, most financial advisors recommend that you first contribute as much as possible to any qualified retirement plans for which you are eligible.

  • Thus, if your employer offers a 401(k) or other type of qualified retirement plan, you should contribute the maximum amount to that plan. Unlike the purchase of an annuity, contributions to a qualified retirement plan may be tax deductible. However, if you have contributed the maximum amount to your qualified retirement plans and would still like to save more money for your retirement, then an annuity may be an excellent way to invest money whereby the earnings will be tax deferred.

Annuities are investments for individuals with long investment time horizon: Annuities tend to be good investments only for individuals who are investing money for the long term. One of the trade-offs to the purchase of an annuity is that the insurance company will usually let you withdraw in the early years only a small percentage (10 percent, usually) of the money you have invested in the annuity without a penalty. If you want to withdraw more than this percentage each year, the annuity issuer will typically charge you a surrender charge. The surrender charge in the early years of the annuity may be as high as 5-10 percent of the amount you withdraw. The surrender penalty will then decline to zero after 5-10 years.

Finally, if you withdraw money before the age of 59½, the tax code tacks a penalty of 10 percent onto the withdrawal. There are some limited exceptions to this early withdrawal penalty tax. Between the surrender charge, the potential income tax liability, and the early withdrawal penalty tax, a substantial part of your investment may be eaten up if you make an early withdrawal from the annuity. An annuity is usually a good investment only for people who can afford to keep their money in the annuity for a period of 10-15 years and who will not begin withdrawals until after the age of 59½.

To determine if a fixed annuity is right for your current financial situation and your long-term investment goals, talk to one of our Osaic Institutions investment executives today!

Contact an Investment Executive


Looking For Additional Information on Financial Planning?

See our resources below.