Fixed annuities trade present-day payments for guaranteed minimum payouts in the future. They can be a great option for investors looking to supplement their monthly retirement income. But like all investments, fixed annuities come with risks as well as rewards.
Before you commit to a fixed annuity, learn what they do — and don't — offer.
A fixed annuity is a special kind of investment option, backed by an insurance company, that provides a guaranteed stream of income after a certain period of time. Fixed and other types of annuities are offered by insurance companies, banks and other financial institutions, often as a retirement-planning tool.
After signing a fixed annuity contract, you'll contribute money in either a large lump sum or smaller monthly payments called premiums. Contributions then grow on a tax-deferred basis over a set period of time called the accumulation phase. Earnings that accumulate are also tax-deferred and are not treated as taxable income until they are withdrawn.
When the accumulation phase ends, you enter the distribution phase. During this time, the company holding the annuity distributes regular payments to you. Payment size depends on multiple factors, including the type of annuity you select and the amount you've contributed over time.
With a fixed annuity, you'll lock in an interest rate and receive guaranteed minimum payouts later in life, distributed in an amount that will be specified in your contract.
If you have an immediate fixed annuity, you'll typically begin collecting payouts within a year after you sign the contract. With a deferred fixed annuity, you'll have to wait longer to begin receiving payouts — generally until you reach retirement.
A fixed index annuity (FIA) is a contract between you and an insurance company where you give the company a certain amount of money for an agreed-upon period of time, and your return is based on the performance of a chosen stock market index or blend of indexes. With FIAs, your principal is guaranteed, meaning that even if the chosen indexes are down at the end of the year, you cannot lose money.
The main advantage of fixed index annuities is their protection from downside risk. As many of our clients approach retirement and are no longer accumulating assets, they do not want 100% of their portfolio to be down if the market has a bad year.
Another big advantage is the annual lock, or reset feature, in which you lock in your gains when the annuity’s index has had a positive return. The growth is then locked in and resets to become the next year’s beginning balance.
Let’s say you have $100,000 in your FIA, and you get a 5% return. The next year, you would begin the year with $105,000. The value of your FIA can only go up or sideways — never down. That is to say, even if the value of the index later decreases or flatlines, your annuity doesn’t lose any money, and you can never fall below your new $105,000 floor, in this example.
You can also use FIAs to generate an income stream in retirement. Almost all FIAs allow you to withdraw 10% of your account value without penalty after the first year. Additionally, some FIA products that include an income rider can generate an income stream for life. Some call this a private pension.
Using FIAs for income become particularly attractive when there's an “income gap” in retirement. Income gap? That simply means your fixed income from Social Security and/or pensions is not sufficient to cover your monthly budget. Using an FIA in this manner can protect your investments in the stock market from having to be liquidated in a down market to generate a monthly cash flow.
Another advantage is that many fixed index annuities have no fees whatsoever assessed to the owner.
We use cookies to analyze website traffic and optimize your website experience. By accepting our use of cookies, your data will be aggregated with all other user data.