What is a Fixed Annuity?

Published by Thomas Herold in Investments, Laws & Regulations, Retirement

'Fixed Annuity' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

A Fixed Annuity refers to a particular form of annuity contract. Insurance companies make such contracts with individuals who are mostly saving for retirement or estate planning. Two main types of these annuities exist, variable and fixed annuities. The fixed one permits investors to add money to the account which is tax deferred. The investor furnishes a lump sum of money in exchange for which the life insurance provides a fully guaranteed and fixed interest rate at the same time as they also guarantee 100 percent of the principle invested. These annuities are often popular for their ability to offer the annuity holder (annuitant) a fully guaranteed income on a regular basis. This can be arranged as a specific number of years or for the remainder of the individual’s life.

The motivation for a person to turn over a large sum of money to an insurance company for such a Fixed Annuity lies in the wish to obtain guaranteed returns while not having any original principal at risk. The second factor centers on the special tax advantages that these contracts with insurance companies enjoy. They receive many of the identical tax advantages from which life insurance policies benefit. Among these are earnings growth on a tax-deferred basis. This does not mean that taxes will not be paid, only that they will not be due until the contract becomes annuitized into monthly payouts or the earnings in the account become withdrawn.

There are a number of advantages to these types of Fixed Annuity investments that continue to draw investors to them year in and out. They offer guaranteed minimum rates, competitive yields which are fixed, guaranteed income payments, withdrawal ability, tax deferred growth, and principal safety.

The guaranteed minimum rates are nice but not forever it is important to note. These exist for an initial period only. The subsequent rates becomes adjusted utilizing a certain formula or alternatively employing whatever the prevailing yield is in the investment accounts of the insurers. Some fixed annuities will also offer an extended minimum rate guarantee as a protection in case interest rates decline in the future.

Competitive yields that are fixed come from the life insurance firm’s investment portfolio which generates them. These investments mostly go into both high quality corporate bonds and U.S. government bonds. This yield is usually greater than a comparable yield on another investment which comes without risk. Many times this will be guaranteed by the insurance company for anywhere from at least one to as many as ten years.

To many annuity buyers, the guaranteed income payments are the greatest benefit to them. This feature becomes activated when the holder converts the fixed annuity into what is known as an immediate annuity. They can do this whenever they wish to provide a fully guaranteed monthly income payout that can last the remainder of the annuitant’s life if they so desire.

Withdrawals are possible with these forms of Fixed Annuities. Holders can take an annual withdrawal every year that is as high as 10 percent of the value of the account. Any amounts greater than 10 percent will be penalized with a surrender charge if this occurs during the surrender period (usually ranging from seven to 12 years from contract start). Every year this surrender charge amount decreases until it eventually reaches zero. At that point withdrawals exceeding 10 percent of the account become penalty-free. There would still be the IRS tax penalty which amounts to ten percent (plus regular income taxes levied as well) on any withdrawals made before the owner reaches 59 and ½ years of age.

Principal safety is a rare commodity in these financially unstable times in the world. Annuities guarantee this, but the strength of the guarantee is only as good as the life insurance company that makes it. This is why investors should only invest their money with those life insurance firms which have at least an A or higher financial strength rating.

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The term 'Fixed Annuity' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.