A fixed annuity contract promises a guaranteed stream of payments as retirement income. You initially fund the contract through one or more payments to the annuity provider, generally an insurer, which promises a fixed return on your contributions regardless of market performance.  

How Does a Fixed Annuity Work?

A fixed annuity is a contract with an insurance company promising a guaranteed return on contributions made as a lump sum or a series of payments over a specified period.  

Annuity Phases

The accumulation phase is the period when you make contributions; the distribution phase is when you make withdrawals. The guaranteed payment period is set out in the contract, and you decide when payments begin. Depending on your policy, payments can last a specified number of years or your entire lifetime. Fixed annuity contracts are sold by insurance companies, banks, brokerage firms, and other financial services companies.  

Deferred vs. Immediate Annuities

A fixed annuity contract or policy can be defined as deferred or immediate, depending on how you fund it and when payments begin. A deferred annuity generally makes no payments during the accumulation phase, which may last at least one year after purchase. This phase can be longer if you fund the annuity with contributions over several years before receiving income. An immediate annuity, by contrast, enters the distribution phase and begins payments within a year of purchase. Payments may even begin immediately after you sign up. An immediate annuity is generally funded with a lump sum.  

Annuities and Cost-of-Living Adjustments (COLA)

Because a fixed annuity provides a fixed return, your savings may not grow as quickly as with investments such as stocks. Once you begin receiving payments, inflation can erode the purchasing power of your annuity income. To address inflation, you can buy a cost-of-living adjustment (COLA) rider. With this rider, payments start lower and gradually increase. For example, instead of receiving $1,000 a month for the contract's life, you could buy a COLA rider starting at $600 a month and increasing 2% each year to keep pace with inflation.  

How Does a Fixed Annuity Compare With Other Annuities?

Variable and indexed annuities share certain features with fixed annuities. However, while they may offer investment returns, they also carry greater risks. A fixed annuity is more stable and predictable, but that predictability has a cost.  

Fixed vs. Variable Annuities

Fixed annuities are the safest annuity type, and the concept is simpler: based on your contributions, an annuity company promises a guaranteed minimum return. You can predict how much your annuity balance will grow over time. With a variable annuity, payments depend on market gains and losses. The insurer invests your contributions in a portfolio of stocks, bonds, and other assets, similar to a mutual fund. If investments perform well, your account balance grows quickly, as do future payments. If investments perform poorly, your balance could shrink, reducing future income.  

Fixed vs. Indexed Annuities

An indexed annuity bases returns on a market index such as the S&P 500. You assume more risk than with a fixed annuity, but less than with a variable annuity. When the index rises, you earn more; when it falls, you earn less. An indexed annuity limits how much you can gain or lose each year through a cap on gains and a floor on losses. For example, a contract might cap good-year gains at 8% and set a 0% floor, meaning you will not lose money in market downturns when the index turns negative. In exchange for this protection, the cap also prevents your annuity's value from increasing as much in very strong market years.  

What Is a Fixed Indexed Annuity?

This is simply another term for an indexed annuity. Returns are based on a stock market index, with a cap and floor limiting potential gains and losses. The annuity industry—life and health financial products—uses this term to suggest that an indexed annuity is a hybrid with features of both fixed and variable annuities.  

Advantages of a Fixed Annuity

• One of the biggest advantages is simplicity. You can easily compare terms and rates to find the best fit. Indexed and variable annuities are complex by comparison. It is relatively easier to identify a good fixed annuity offer because contract terms are clearer.
• Fixed annuities guarantee a minimum investment return for the life of the contract. Their rates are often higher than those available on a CD or savings account, offering low risk with higher returns.
• Because a fixed annuity generates a fixed return, you can predict future earnings, making retirement planning easier. With variable and indexed annuities, actual returns depend on investment performance. You could earn more—or much less—but either way, you will not have a clear picture of future income.

 

Disadvantages of a Fixed Annuity

• Although a fixed annuity can help you avoid market losses, the trade-off is that you do not share in market gains. In strong market years, a variable or indexed annuity could grow your savings faster than a fixed annuity.
• Insurers guarantee a fixed minimum return only for a certain number of years after the policy is established. They continue paying interest afterward, but the renewal rate may be lower than your initial rate, depending on the contract.
• During high inflation, a fixed annuity may not provide much growth, so you need to add a COLA rider to help offset inflation's erosion of value. As noted earlier, a COLA rider can reduce your initial payments.
• Fixed annuity payments are taxable. While money remains in the annuity, it grows tax-deferred, but once you take your earnings, withdrawals are taxable.
• As with retirement accounts, withdrawals before age 59½ are subject to a 10% penalty on the amount withdrawn.
• Unlike investment products and bank accounts, fixed annuities are not regulated by the federal government. These contracts are regulated only at the state level by each state's insurance commissioner. Companies selling fixed annuities and their agents must register with the commissioner in every state where they do business. State government ensures they operate properly and handles customer complaints.

  As you weigh your options, speak with a financial advisor about fixed annuities for a more detailed explanation of what best suits your personal finances.