What Are the Pros and Cons of a Fixed Annuity?

A fixed annuity is a stable, long-term investment product offering guaranteed returns and predictable payouts. Insurance companies sell the contracts as stable options for retirement savings.

Tax-deferred growth and protection from market volatility are attractive features of a fixed annuity. However, the investment product lacks inflation protection unless riders are added, and the surrender charges for early withdrawals limit liquidity.

Learning about the pros and cons of a fixed annuity can help you decide whether purchasing one fits your financial goals. The following details can help.

What Is a Fixed Annuity?

A fixed annuity is an insurance contract that offers a guaranteed rate of return for a set time, or until the policyholder passes away. Some pay out to a beneficiary after the policyholder’s death.

A fixed annuity is typically suitable for conservative investors who value guaranteed income and security. Conversely, this type of contract is not a good option for investors seeking higher growth or flexible access to their funds.

How Does a Fixed Annuity Work?

These guidelines show how a fixed annuity works:

• You give the insurance company either a lump sum of money or regular payments.

• The insurance company credits your account a guaranteed interest amount annually, regardless of market performance.

• Taxes are deferred until you begin making withdrawals.

How Do Fixed Annuity Rates Work?

Insurance companies set annuity rates that remain the same throughout the contract term. The two main factors to focus on when considering purchasing a fixed annuity include:

1.  Annual percentage yield: The annual percentage yield (APY) is the annual rate you’ll earn throughout the contract term.

2.  Annuity rate: Factors such as current interest rates, market factors, and premium amounts impact a fixed annuity’s rate.

What Are the Pros of a Fixed Annuity?

The following are the pros of a fixed annuity:

• Set interest rates: The interest rates are typically higher than the rates of savings accounts or certificates of deposit (CDs).

• Guaranteed returns: A minimum-rate guarantee protects against declining interest rates. This rate is the lowest amount you will be credited for the money you deposit and accumulate.

• Tax-deferred growth: You pay taxes on your earnings at the time of withdrawal.

• Predictable income: A fixed earning rate, unaffected by market volatility, provides stable, predictable income during retirement.

What Are the Cons of a Fixed Annuity?

The following are the cons of a fixed annuity:

• Surrender charges: The surrender period, or period of time you must wait before making withdrawals, can be up to 15 years from the contract’s start date.

• Limited liquidity: You cannot make withdrawals at will. However, some insurers allow a penalty-free 10% withdrawal annually. You might be able to add riders to your contract for increased liquidity under specific circumstances, such as terminal illness or long-term care.

• Limited earnings: You cannot completely leverage market highs because your gains are fixed at a set percentage

• Lower returns: Rates for a fixed annuity are typically lower than the potential returns of stocks and mutual funds.

• Lack of inflation protection: A fixed rate of return means your annual payments remain the same, decreasing your purchasing power as inflation increases. You might be able to add riders to provide some inflation protection, such as a cost-of-living adjustment rider.

*This information is for educational purposes only.