Planning for retirement is a critical step toward securing financial stability in your later years, and understanding the tools at your disposal can make all the difference. One such tool is a fixed annuity—a dependable, tax-deferred investment that guarantees steady income, making it a popular choice among retirees. This blog explores what fixed annuities are, how they work, their benefits, and factors to consider before adding them to your financial plan. Whether you're looking for a predictable income stream or a low-risk way to grow your savings, a fixed annuity may be worth considering.

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What Is a Fixed Annuity?

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A fixed annuity is an insurance company contract similar to a bank's certificate of deposit. You pay one or more premiums in exchange for the insurer guaranteeing a fixed rate of return on your investment to grow the account balance. This rate is usually locked in for several years, generally five years. When the initial period expires, the insurer resets periodically, usually every year, the interest rate. The rate, however, can never be lower than the guaranteed minimum interest rate outlined in the policy.

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How a Fixed Annuity Works

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An annuity is one of those bizarre investment products in which, supported by an insurance company, a guaranteed income is generated after a certain fixed time. Fixed annuities are issued by insurance companies, banks, and other financial institutions and have been designed to form part of retirement planning.

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You purchase a fixed annuity by making a single lump-sum payment or smaller, periodic payments, called premiums, in exchange for the annuity contract. Your contributions grow tax-deferred-meaning you don't pay taxes on earnings-until you withdraw them-during the accumulation phase.

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When the accumulation phase is over, you enter the distribution phase, whereby the insurer pays periodic income to you. How large the periodic income payments will be is determined by factors that might include the type of annuity and how much you have contributed.

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With a fixed annuity, you lock in a fixed interest rate guaranteed with minimum payments per your contract. Under an immediate fixed annuity, which is the common type of payout, the payout shall happen within a year from the date of signing the contract. In the case of a deferred fixed annuity, you will begin to receive the payment later than normal, normally at retirement.

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Benefits of a Fixed Annuity

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There are several reasons why people choose fixed annuities, including:

• Dependability: Along with a guaranteed fixed interest rate, your principal (the money you invested in the annuity) remains intact unless you withdraw funds or terminate the contract early.
• Tax-Deferred Growth: The interest earned on your annuity grows tax-deferred, meaning you don't pay taxes on the earnings until you withdraw them. This can provide a tax advantage, especially if you make withdrawals when you're in a lower tax bracket.
• Compounded Growth: Interest earned on your annuity also generates additional interest, known as "compound" interest. This allows your investment to grow further as long as you hold the annuity (subject to age limits).
• Guaranteed Income: After the first year, you can convert your annuity balance into a guaranteed stream of income for a set period or even for the rest of your life, depending on your choice.
• Flexible Withdrawals: You can access your annuity funds at any time, either through a lump sum or scheduled income payments. However, early withdrawals may come with charges and tax consequences, especially before age 59 ½. Once your payments have started, changes cannot typically be made.

Things to consider before buying a fixed annuity

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Adding a fixed annuity to your retirement plan may be very rewarding and could provide a steady flow of income with less overall investment risk. If you are considering establishing a fixed annuity, here are some things you will need to carefully think about:

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1. Income Payment Term

Determine how long you want the income payments to last: fixed annuities can offer regular payments for a set number of years or for the rest of your life. Generally speaking, longer payment periods tend to result in smaller individual payments. Adding features such as a death benefit may decrease the size of each payment.

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2. Death Benefits

Now, consider the annuity's death benefit feature. The death benefit can provide an amount to the named beneficiary based on the balance remaining in the annuity at date of death. Some will provide a lump sum and others ongoing payments based on the contract. Review the annuity contract carefully and consult with your financial advisor regarding implications for your beneficiary and potential taxes.

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3. Qualified vs. Non-Qualified Annuities

Know what's going on with taxes in regard to your annuity. Qualified annuities are those that you pay for with pre-tax dollars, such as from your 401(k) or an IRA. Income taken is taxed as ordinary income. A non-qualified annuity is one that you paid for with after-tax dollars (that is, you've paid income tax on the contributions), so only the earnings are taxed upon withdrawal.

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4. Surrender Charges and Fees

Be leery of the surrender charges and early withdrawal penalties. Almost all annuities will penalize you for taking out money quicker than the duration of the contract. Secondly, there is a 10% penalty imposed by the IRS on withdrawals prior to 59 ½ years of age. Keep your head on a swivel regarding these potential added costs to reduce possible surprises.

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5. Insurer Integrity

With fixed annuities, the reliability of the annuity is based upon the financial strength of the insurance company that issued it. Check the insurance company's financial strength ratings with major independent rating agencies for a history of meeting financial obligations. A strong rating means the company is in a good position to meet its responsibilities and continue to pay your annuity.

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Taking these factors into consideration will better help you make an appropriate decision on whether a fixed annuity really meets your retirement goals and financial needs.

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Fixed Annuities vs. Variable Annuities

Fixed and variable annuities are both tax-advantaged insurance products designed to provide periodic payments during retirement, potentially extending throughout the retiree's lifetime or to their beneficiaries. While they share similarities, they differ significantly in how they operate and the benefits they offer.

Fixed Annuities

• Guarantee: Fixed annuities provide a guaranteed payment amount, regardless of market conditions. Your payments remain consistent during the payout phase.
• Risk Level: They are considered a more conservative option because they offer stable growth through a fixed interest rate. This guarantees a predictable income stream, making them suitable for those with a lower risk tolerance.
• Growth Potential: The growth potential is limited compared to variable annuities, as the returns are fixed and do not fluctuate with market performance.

Variable Annuities

• Market Dependence: Variable annuities are influenced by market performance. During the payout phase, your payments can vary depending on the performance of your chosen investments, such as mutual funds.
• Risk Level: They are riskier than fixed annuities due to their dependence on market fluctuations, but they offer greater growth potential. The asset mix, which includes various investment options, can potentially lead to higher returns.
• Fees: Variable annuities often come with higher fees, including management fees for the investment options and potential surrender charges.

Choosing between a fixed and variable annuity depends on your risk tolerance and your retirement goals. Fixed annuities offer stability and predictability, while variable annuities provide the opportunity for greater growth but come with increased risk and fees.

Conclusion

Fixed annuities can be a valuable addition to a well-rounded retirement strategy, offering the stability of guaranteed payments, tax-deferred growth, and compounded interest. However, it’s essential to evaluate key factors like insurer integrity, payment terms, and potential fees before committing. While fixed annuities are a great option for those seeking financial security, other opportunities, such as high-yield investments, may also help diversify your portfolio.

For instance, Compound Real Estate Bonds (CREB) offers an excellent alternative with an 8.5% APY, no fees, and the flexibility of anytime withdrawals. Backed by real assets and U.S. Treasuries, CREB provides a fixed income opportunity that complements traditional retirement options like fixed annuities. Whether you choose a fixed annuity, CREB, or both, aligning your investments with your goals ensures a more secure and fulfilling retirement.