An annuity is a popular option for individuals that are retirement planning. In particular, a fixed annuity poses great benefits for those looking to establish financial security through additional income. Essentially, a fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account. Someone might purchase an annuity if they need to supplement their other retirement income such as social security or pension.
An individual that wants to invest in an annuity can either buy it with a lump sum of money or with a series of payments over time. In turn, the insurance company guarantees that the account will earn a certain rate of interest. This is known as the accumulation phase. When the owner of the annuity is ready to receive a regular income, the insurance company will determine the payments based on the amount of money in the account, the owner’s age, how long the payments are to continue, and a few other important factors.
Difference Between a Fixed and Variable Annuity
The main difference between a fixed and variable annuity is that a fixed annuity guarantees payments of a set amount based on the term of the agreement. This means that the payments cannot go up or down. A variable annuity, on the other hand, fluctuates with the returns of the mutual funds it is invested in. Unlike a fixed annuity, a variable annuity can go up and down.
Advantages of a Fixed Annuity
A fixed annuity poses many advantages for individuals who need to increase their financial security for retirement. Here are 5 advantages of a fixed annuity to consider.
One of the main benefits of a fixed annuity is the investor’s ability to receive guaranteed returns. Many investors who are preparing for retirement are not comfortable investing in volatile markets such as the stock market. Often times, investors prefer to make secure investments that can improve their financial planning for the future.
With guaranteed returns also comes guaranteed income. This is especially important for individuals who are retirement planning. Other income such as social security and pension aren’t always enough to live on, which is why a fixed annuity can be a great option. A fixed annuity helps to fill the financial gap as the insurance company will pay you a consistent income for the rest of your life.
Another advantage of a fixed annuity is that it is a tax-deferred product. This means that the money you put into an annuity will continue to grow and is tax-free until you decide to pull it out. It’s important to note that when investors decide to pull out their annuity, the tax burden will be based on an exclusion ratio, which is the relationship between your account value when you initially started it and the cost basis.
Low Initial Investment
A fixed annuity is also great for investors who want to put in a low initial investment. Some investment accounts require thousands of dollars to get started. However, it is possible to get started with as little as $1,000 with a fixed annuity.
Flexible Payout Options
If you’re looking for variety when it comes to your annuity payout, a fixed annuity is a favorable option. For starters, an individual can draw income from their annuity at any time. This is especially beneficial for those who find themselves needing emergency cash. In addition to this, individuals will have a few withdrawal choices to choose from when they’re ready to pull their money. Here are 3 withdrawal options.
- Straight life: Investors will receive consistent payments each month for the rest of their life
- Joint life: Investors will receive consistent income payments each month for the rest of their life and their spouse’s life.
- Lump-Sum: Investors can choose to receive their money as a one-time lump sum payment. Keep in mind, you could incur surrender charges or a 10% early withdrawal fee.
Disadvantages of a Fixed Annuity
While a fixed annuity certainly has excellent advantages, there are some disadvantages that individuals should consider. Here are 3 disadvantages of a fixed annuity.
Loss of Flexibility
One disadvantage of a fixed annuity is the loss of financial flexibility. When an individual is ready to receive their withdrawals, the insurance company will pay a set amount each month. However, this amount does not change. With that said, if an emergency situation comes up, there won’t be the same freedom to redeem your policy for cash as the insurance company owns the principal investment.
Fees and Commission
Another disadvantage of a fixed annuity is that these policies come with built-in fees, which ultimately cuts into your return. For investors who want to maximize their return value, an annuity may not be the most favorable option.
It’s important to note that while fixed annuities have fees, they are generally less expensive when compared to variable and index annuities. Here are some typical fees you can expect to encounter.
- Surrender charge: This is a charge that comes into play when an investor surrenders their policy within a certain timeframe. However, you can expect the surrender charge to decrease the closer you are to the end of the period.
- M&E Charge: Fixed annuities come with morality and expense, and administration fees. These fees are generally built into the interest rate on your account balance.
- Commissions: In general, annuities are sold as commission products. With that said, an advisor that recommends a product might receive a commission if you purchase from them. This commission is paid by the insurance company. However, it’s important to keep in mind that some advisors are focused on earning the commission, meaning the product they offer you may not always be in your best interest.
Another disadvantage of fixed annuities is that there are typically longer terms. Essentially, an annuity is a long-term commitment and investors must be prepared for this. It will cost you if you decide down the line that you want to cash out, which might not be worth it in the end.
A fixed annuity is a great option for individuals who want long-term accumulation with tax advantages. In addition, a fixed annuity can provide financial security for those that are retirement planning. With that said, a fixed annuity has some disadvantages such as a loss of financial flexibility, fees, and a longer commitment period.
If you have any additional questions about retirement planning or want to learn more about fixed annuities, feel free to visit our website to learn more.