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If you're worried about outliving your money, a fixed annuity is worth considering. You pay a sum of money in exchange for a stream of fixed payments. A fixed annuity can make sense in some situations, but this financial product isn't right for everyone. We'll explain how fixed annuities work and weigh their pros and cons.
A fixed annuity is an insurance contract where you pay an upfront sum of money in exchange for a steady income and a guarantee from the insurer that your principal will grow at a fixed rate. The rate is determined by the insurance company at the time you sign the contract. However, some fixed annuities only guarantee a minimum interest rate for a portion of the contract.
Although the insurance company guarantees a minimum interest rate, sometimes the insurer will credit the policy with an interest rate above the minimum if the company outperforms and its board of directors approves a dividend.
There are several ways a fixed annuity can be structured.
A deferred fixed annuity is an annuity that you fund in exchange for payments at a later point in time. An immediate fixed annuity begins providing income immediately after purchase.
A single-premium fixed annuity is one that you purchase with a lump sum of money. A flexible-payment fixed annuity is funded by payments over time. Flexible-payment annuities are always deferred; a single-premium annuity can be immediate or deferred.
A lifetime annuity provides income for the rest of the life of the annuitant (the person who purchased the annuity). A fixed-period annuity provides income for a set period, like 10 or 20 years.
Many people buy fixed annuities as part of their retirement planning because they're seeking financial security. However, there are important advantages and disadvantages to consider.
A fixed annuity makes the most sense if you're concerned that you may outlive your retirement savings. It may be worth considering if you're in excellent health and have a family history of longevity, but it's usually not a good option for someone who doesn't have a long life expectancy.
Before you sign a fixed annuity contract, be sure you understand the following:
Suppose you're looking to supplement your retirement income, so you shop for fixed annuities. You're 70 years old, and you're seeking to annuitize, or draw income, from the contract in 10 years.
For $50,000, you could buy a single-life-only fixed annuity. You'd get monthly payments of $904 for life when you start drawing from the contract, but when you die, your heirs are left with nothing.
You could also use your $50,000 to buy a single-life annuity with 20 years certain. You receive the income for life, but if you die in the first 20 years, your beneficiaries receive any remaining payouts. But because the insurer is on the hook for at least 20 years of payments, your $50,000 would only buy you $573 of monthly income.
