The Pros and Cons of Fixed Annuities

Fixed annuities have a lot of appeal to people who have a distaste for market fluctuations and like to play it safe. By purchasing a fixed annuity you invest a certain amount of money and in turn either receive checks periodically or take home a lump sum at the end of the term — e.g., income annuity vs. deferred annuity. Acting as a safety net against financial debacles, fixed annuities guarantee the return of the principal amount no matter what happens. However, before you decide to choose fixed annuities it will be wise to know some important details.

Why should you consider fixed annuities? (the pros)

  • The risk of losing your money is minimal. You will get back your money even if the insurance company becomes insolvent. The state covers policies up to a certain amount in case the insurance company goes bankrupt. However, if the investment amount is above the state determined limit and the company becomes insolvent then you will end up losing money.
  • The rate of interest is fixed. This means that you don’t have to get tensed whenever the market becomes unstable. You are assured of a fixed sum of money.
  • Deferred fixed annuities are tax deferred. So you will enjoy a tax-free growth.  You will be taxed only when you start receiving payments.
  • There are short-term as well as long-term fixed annuities. You have the option to choose what is most convenient to you. If you choose immediate fixed annuity then you will start getting payments within a short period. It may be as soon as a month after purchasing the annuity.  If fixed deferred annuity is your choice then you will be paid after a relatively long period of time. You can choose between a lump sum and monthly payments.
  • Most fixed annuities have lifetime income provision. This would mean that you will receive money periodically throughout your life. This makes fixed annuities a smart part of an overall retirement plan. You can reduce the risk of outliving your retirement income.
  • Some fixed annuities have an optional life insurance provision which offers death benefits to your loved ones. They also allow you to leave money to your loved ones probate free.

Fixed annuities are not a perfect solution either (the cons)

  • Annuities are financial products sold by insurance companies, as such, they could be expensive compared to other non-annuity options
  • You will be charged a 10% penalty by IRS for premature withdrawal. You can withdraw only when you are 59.5 years old.
  • Deferred fixed annuities are usually not suitable for young people because they cannot be withdrawn before a certain period of time.
  • Interest rates are not high compared to the potential returns of other investments such as mutual funds.
  • Extra money cannot be added to the same annuity contract. You have to purchase a separate annuity to increase your investment.
  • Tax-deferred growth in deferred fixed annuities is taxed as ordinary income, and not capital gains.
  • Fixed annuities can be very tricky to manage for maximum returns since the cost of insurance features can eat into the return that you get on your initial investment.
  • Fixed annuity contracts are complicated and people who do not understand them may end up paying a great deal of money for an investment that does not serve its intended purpose.

A few important things to remember

  • The right time to purchase a fixed annuity is when the interest rates are high.
  • Long-term fixed annuities have higher interest rate but less flexibility. On the other hand short-term fixed annuities have more flexibility but lower interest rate.
  • A smart person will opt for multiple investment plans. Fixed annuities are a good option but apart from them you should also consider mutual funds, bonds, treasuries etc.

Fixed annuities can help preserve your capital and is another way to help you reduce your overall risk; especially, longevity risk. Depending your your needs, their advantages could outweigh their disadvantages. As always, it is wise to analyze your situation — your needs and your age — and choose your options accordingly.

About the Author

By , on May 6, 2010
Andy Tenton
Andy is a 30-something New Yorker who turned his financial life around. He took charge of his finances, got out of debt, and is now working his way toward financial success. He is the owner and publisher of WorkSaveLive.com.

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Leave Your Comment (3 Comments)

  1. Mike @ Annuity Rates says:

    Every retiree has his own savings that they need to turn into a source of income. And annuity is designed exactly to do so. That’s why there is a logical appeal to annuity. But in my view, all annuity products might not be equally suitable for people of all ages. I think fixed type of annuity suits most with the people reaching their retirement.

  2. Every coin comes with 2 sides. The ardent fans of fixed annuities should realize this fact. Annuities have bunch of shortcomings which are discussed nicely in this blog. Consult a professional before investing in annuities to reap maximum rewards.

  3. The Money Paradise says:

    Every thing has some pros and cons so is fixed annuities. But if one look at from one side only then will look like having more cons than pros.
    It is very good for old people as they hardly have other incomes than a fixed income from pension or retirement corpus. So it suits to them but in case of young people it is an unattractive business. they look for higher returns and over period of time annuities loose their shine.

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