What is a 'Fixed Annuity'
A fixed annuity is a type of annuity contract that allows for the accumulation of capital on a tax-deferred basis. In exchange for a lump sum of capital, a life insurance company credits the annuity account with a guaranteed fixed rate of interest while guaranteeing the principal investment. A fixed annuity can be annuitized to provide the annuitant with a guaranteed income payout for a specified term or for life.
BREAKING DOWN 'Fixed Annuity'
Fixed annuities are contracts issued by life insurance companies to individuals looking for guaranteed rates of return without any risk to principal. Because they are a type of insurance contract issued by a life insurance company, they enjoy some of the same tax benefits of life insurance policies, such as tax-deferred growth of earnings. Taxes are eventually paid when the earnings are withdrawn or when the contract is annuitized for monthly payments.
Key Features of a Fixed Annuity
Competitive Fixed Yields: The rates on fixed annuities are derived from the yield a life insurance company generates from its investment portfolio, which is invested primarily in high-quality corporate and government bonds. The yield on fixed annuities is typically higher than the yield on equivalent, riskless investments and is often guaranteed for a period of one to 10 years.
Guaranteed Minimum Rates: Once the initial guarantee period expires, the rate is adjusted based on a specific formula or the prevailing yield earned in the insurer’s investment account. As a measure of protection against declining interest rates, fixed annuity contracts include a minimum rate guarantee.
Tax-Deferred Growth: As a tax-qualified vehicle, fixed annuities offer tax-deferred accumulation of earnings. For people in the higher tax brackets, this can make a significant difference in the amount accumulated over time. When the earnings are withdrawn or taken as income, they are taxed as ordinary income.
Withdrawals: Fixed annuities allow for one annual withdrawal per year up to 10% of the account value. During the surrender period, which runs from seven to 12 years from the start of the contract, withdrawals over 10% are subject to a surrender charge. The surrender charge declines each year so that, when it reaches zero, withdrawals can be made without penalty. Withdrawals made prior to age 59 ½ may be subject to a tax penalty of 10% in addition to ordinary income taxes.
Guaranteed Income Payments: Fixed annuities may be converted to an immediate annuity at any time to generate a guaranteed income payout for a specified period of time or for the life of the annuitant.
Safety of Principal: The capital invested in a fixed annuity is guaranteed by the life insurance company. For that reason, investors should only consider investing with life insurance companies rated A or better for their financial strength.