Does a Fixed Annuity Fit In Your Retirement Plan?

A fixed annuity provides guaranteed returns but limited flexibility.

Fixed annuity contract with money in it.
Fixed annuities are like CDs, but with tax deferral. spxChrome

A fixed annuity is a contract with an insurance company. The insurance company guarantees the rate of interest you will earn on money deposited in the annuity contract. Below are the basics, and a guide to when and how fixed annuities can fit into your plan.

Fixed Annuity Basics

A fixed annuity is most comparable to a certificate of deposit (CD) issued by the bank, except with a fixed annuity, the interest you earn accrues inside the annuity and is not taxable until you withdraw it from the annuity.

With a CD the bank sends you a 1099 tax form each year which reports the amount of interest you earned, and you must report this interest on your tax return even if you let it accrue in the CD.

Like a CD, a fixed annuity pays a guaranteed return. Sometimes the return is front-loaded, so there may be a higher interest rate in year one, but a lower rate in years two through ten. Like a CD, there is a term assigned, such as a five-year fixed annuity. Some fixed annuities have terms as long as fifteen years, and if you surrender the annuity before the term is up you will pay a surrender charge. Don't get caught up in high first-year interest rates. You need to calculate the yield if held for the full term of the annuity contract to accurately compare one offering to another.

Best for: If you have a long time-frame and want a no-risk investment, you might pick a fixed annuity over a CD to defer the taxes, and possibly earn a higher interest rate than what the banks are paying.

This might be a good choice for funds you inherit or a bonus you receive.

There are two main types of fixed annuities; deferred and immediate.

Deferred 

With a deferred fixed annuity (often called deferred income annuities or DIAs) you receive a guaranteed amount of interest which accumulates inside of the annuity contract.

The interest is tax-deferred, so no income taxes are paid until you take a withdrawal.

You can buy a deferred fixed annuity with IRA money, in which case the tax rules that apply to IRAs will apply to all funds in the annuity.

You can also buy a deferred annuity with non-qualified money (non-IRA funds). Withdrawals taken before age 59 1/2 may be subject to penalty taxes as well as income taxes. When you take a withdrawal interest is withdrawn first. Once you have withdrawn all the interest, then you begin to withdraw principal, which is a return of what you put in (your cost basis). Principal withdrawals are not taxed.

Most deferred fixed annuities have a feature which allows you to access up to 10% of the contract value each year without having to pay the surrender charge.

If you are looking for the highest interest rate, you can compare deferred fixed annuity rates to alternatives that may offer more flexibility, such as certificates of deposits, or a ladder of high-grade bonds that allow you to keep your principal with minimal restrictions on accessing your money.

Income Rider Benefits

Many deferred fixed annuities offer additional benefits beyond the guaranteed rate. For example, they may have a guaranteed income rider, which states the specific amount of retirement income that can be paid out to you ten or twelve years in the future.

With this type of product, you are buying it to secure a certain outcome. It is not about the highest rate of return; instead, it is about making sure you have a minimum amount of guaranteed income for your retirement years.

Best for: Deferred fixed annuities with income riders can be a good fit for someone who is about ten years away from retirement. If the market drops right near your retirement date, it won't matter. This product guarantees the future income it will pay out to you no matter what the market does!

Immediate

With an immediate fixed annuity, you exchange your lump sum of money for a guaranteed payment of income from the insurance company that starts right away. These products are called single premium immediate annuities or SPIAs. Once the annuity payments begin, they do not change unless you purchase an annuity that adjusts with inflation.

 

When the annuity income payments start, you no longer have access to the principal. Instead, you have a right to the income the insurance company has promised you. You will choose the term of your payments, such as guaranteed income over ten years, or over your entire lifetime. 

Best for: A fixed immediate annuity can be an appropriate addition to your retirement plan if you are:

  • Retired, or retiring soon
  • Wanting to make sure more of your expenses are covered by guaranteed income
  • Risk adverse and prefer safe investments
  • Single or recently became widowed
  • Concerned about spending down your funds too quickly