How Do Annuities Work? Your Fixed Annuities Guide
The fixed annuity is an investment contract between an annuitant (investor) and an insurance company. The insurance company agrees to pay the annuitant a fixed income for a period of time based upon the value invested in the annuity. For this reason fixed annuities are also referred to as fixed income annuities.
There are numerous types of fixed annuities, ranging from payments for a set period of time to payments that are dependent on the life span of an individual. The type of the fixed annuity depends entirely on the structure needed for the individual investor.
Fixed annuities are often misunderstood by investors, and as a result carry a certain degree of uncertainty. Many people ask themselves: how do annuities work? In order to successfully and prudently invest in annuities one must form in their mind at least a general understanding of how exactly do annuities work. As with other investments, it is important to fully educate yourself regarding annuities before making a decision. It is important to seek the advice of qualified professionals regarding any investment. Individual circumstance warrant different investment approaches. On this site you will find specific articles intended to give an unbiased description of the fixed annuity, and to provide information on the various aspects of this useful financial product.
What Are The Different Types of Fixed Annuities?
Unfortunately one cannot simply ask: how do annuities work? Because the answer really depends on the different types of fixed annuities you are interested in (on this website we opt to ignore variable annuities and focus on fixed annuities, hence the site name). Despite the many different types of fixed income annuities, fixed annuities will always fall under one of two categories: deferred or immediate.
This concept is pretty straightforward. For an immediate annuity, the first payment from the insurance company is due one payment interval from the date of purchase. If the payment will be paid out monthly, then payments start one month after purchase of the contract. Yearly payouts begin one year after first payment. A deferred annuity requires the fixed annuity to be purchased over a period longer than just one payment.
Other types of fixed annuities include: annuity certain, life annuity, joint annuity, joint and survivor annuity, life annuity certain, and an equity-indexed annuity among others. The differences between these types of fixed annuities are found in the duration of payouts, the designated life on the contract, payment certainty, and bonus stipulations. You’ll find some good information on each of these different fixed annuity types in the information center post: What Are the Different Types of Fixed Annuities?
What are the Advantages of a Fixed Annuity?
One of the most appealing aspects of a fixed annuity is that it pays a fixed dollar amount for the duration of the investment. This can be a particularly appealing feature in times of market volatility (something pretty common these days). The fixed annuity behaves similar to a CD, and provides a guaranteed payment for the duration of the payout period.
Some types of fixed annuities, such as the equity-indexed annuity, will actually pay a minimum interest rate in market downturns, and then provide a bonus during the market’s up years. This can be a very effective way to protect the principal of your investment, and still participate in market upswings. The stipulation with this type of annuity is that it is subject to caps and/ or participation rates. This more or less just means that you only “participate” in a portion of the market growth, or that the growth is “capped.” See the information center for articles on What is an Annuity Cap and What Does the Participation Rate Mean.
Another appealing attribute of fixed income annuities is the ability to provide income for the duration of an individual's life. A lifetime annuity gives retirees a fixed income that they will not outlive. This can be a powerful tool to provide additional security during retirement.
See article on the advantages of a fixed annuity for more information.
What are the Disadvantages of Fixed Annuities?
As with any investment, there are both pros and cons to the financial vehicle. This is very much the case with fixed annuities. While the fixed annuity can provide a definite and recurring stream of income, it can also come with steep penalties if you change your mind. Most annuity contracts have sharp surrender penalties if you attempt to get your money out faster than the predetermined rate. This also makes the investment rather illiquid.
Another weakness of many fixed annuity products is that they generally do not adjust for inflation well. Fixed rate annuities with life income will gradually lose their purchasing power over time. Not all fixed annuity products have this problem, and simply understanding that this can happen can allow you to implement strategies to combat this problem. Many weaknesses of financial products can be overcome with comprehensive financial planning.
See article on the disadvantages of fixed annuities for more information.
Fixed Annuity Summary
The fixed annuity can be a very useful financial planning tool, particularly in retirement planning. Individuals looking for a steady and guaranteed income will find the fixed annuity to be particularly effective. As with all investment vehicles, it is very important to understand the facts before placing your financial future in jeopardy. Be sure to find a financial advisor that you trust and that has your best interest at heart. Fixed annuities are not for everyone. Investment in fixed income annuities should only be undertaken after careful consideration.
For more information on fixed annuities, be sure to explore the rest of the website. The information center is full of detailed information that on key terms and topics that you will be faced with when considering a fixed annuity purchase. They aim to answer the question: How Do Annuities Work? If you find a topic that hasn't been addressed, you are welcome to send us topic suggestions.
If you are ready to start the process, head on over to our quote page and get your customized annuity quote. We have a simple form to fill out to help you get on your way to comparing rates, companies, and products for your unique situation.