A fixed annuity is an investment vehicle offered by an insurance company that guarantees to pay a stated rate of interest for a specified period of time. The investor has the choice to accumulate the interest on a tax-deferred basis or take it as income. With a fixed annuity, the insurer, not the insured, accepts the investment risk.
During a fixed annuity's accumulation period, an investor's assets are invested for a specific period of time (the guarantee period). Generally, guarantee periods range from one to ten years; the longer the guarantee period, usually the higher the rate of interest. Renewal rates are announced near the end of the guarantee period. At that time, the investor needs to review his or her options.
During the payout period, the assets that have accumulated may be returned to the investor based on a fixed annuitization option. Investors may also elect to withdraw their interest. Withdrawals are taxed as ordinary income. IRS regulations may impose a 10% penalty if withdrawals are made prior to age 59 1/2. Withdrawals of principal during the guarantee period may also be subject to surrender charges or market value adjustments.
The primary objective of fixed annuities is to provide investors growth of principal and interest that is free from taxes until withdrawn.
Fixed annuities are an investment alternative for investors seeking growth of principal for purposes such as retirement planning.
- Lifetime Income - Annuities can provide income for various lengths of time, including a lifetime. A lifetime annuitization option is normally only available from an insurance company.
- Choice of Guarantee Periods - The guarantee period an investor selects should be based on their investment time horizon and diversification strategy. Fixed annuities generally offer guarantee periods from one to ten years.
- Guarantee of Interest and Principal - The value of a fixed annuity will increase every day that interest is added to the contract. Interest is usually compounded annually and credited daily. The guarantees offered by a fixed annuity are backed by the claims-paying ability of the issuing insurance company.
- Tax-deferred Growth - Interest accumulates tax-deferred and is not subject to taxes until withdrawn. Upon withdrawal, the earnings will be taxed at ordinary income tax rates. Note: There are no tax advantages to purchasing a fixed annuity in IRAs, 401(k)s or other similar retirement savings vehicles.
- Flexible Income Options - During the guarantee period, an investor has the option to take systematic withdrawals, usually limited to their interest. Investors have the option to start, stop, and adjust their withdrawal amount, subject to certain limitations. An annuity's income stream can also be guaranteed by the insurance company for as long as the investor lives.
- Probate Avoidance - Fixed annuity proceeds paid to the beneficiaries upon the investor's death are excluded from probate on their estate; however, the tax-deferred earnings in the contract will be subject to ordinary income tax, and estate taxes would apply to the total value of the contract, if applicable.
- Penalty for Early Withdrawal - A 10% IRS penalty is assessed on any interest withdrawn from a fixed annuity prior to age 59 1/2.
- Penalty for Early Surrender - Investors are assessed a charge for the early surrender of fixed annuities.
- Benefit to Spouses - Spousal beneficiaries may usually continue tax deferral if so desired.
Fees and Expenses
Most fees and expenses of a fixed annuity are factored into the stated annual percentage rate the investor is quoted. The rate quoted is the rate paid. Fixed annuity fees and expenses generally cover the insurance company's administrative expenses and the cost of offering the annuitization guarantee and profits to the insurance company and agent. Some fixed annuities may assess an annual contract fee, typically around $30.
Contact a STRIVE Wealth Advisor for more information about fixed annuities.