Fixed income annuities turn the contributions you make today into a guaranteed income stream at a later date. When planning for future lifestyle changes like retirement, this predictability ensures you’ll have enough to cover all of your expenses.

Read on to learn more about how fixed income annuities work and why they can be a good addition to your financial plans.

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What’s a fixed income annuity?

Fixed rate annuities offer guaranteed interest, and insurers will send payouts for a predetermined period of time, sometimes the rest of your life. Even if your initial contribution and earned interest doesn’t cover the entire value of your expected distributions, the insurance company is required to send you these payments.

This differs from other types of annuities, such as: 

• Variable annuities: Variable annuities invest your money in assets that are linked to market performance. These don’t offer a guaranteed rate of return, which can affect the value of your future payouts.
• Indexed annuities: Indexed annuities are tied to broad stock market indexes such as the S&P 500^®. Like variable investments, this means your growth may not be consistent, although indexed annuities may offer protection against market downturns.

If fixed income annuities fit your portfolio, there are several to choose from.

Types of fixed income annuities

Straight life annuities

Also known as a single life annuity, a straight life annuity only sends payouts to one person. When you pass away, your beneficiaries don’t receive any remaining payments or principal funds unless you attach a death benefit rider to your account. Despite this, straight life options may be appealing because insurance companies typically offer higher monthly payouts.

Term certain annuities

With this option, you receive regular (often monthly or quarterly) annuity payouts over a predetermined time period, usually 10 or 20 years. If you die during the term, your beneficiary continues to receive your benefit.

Substandard health annuities

Substandard health annuities are specifically aimed at people with shorter life expectancies or serious health conditions. These annuities deliver higher payouts because the insurance company expects to make the payments for a shorter period of time.

Joint and survivor annuities

This type of fixed rate annuity covers two people, typically spouses. As long as one person is alive, the annuity continues to generate guaranteed income. In this case, payments may be lower because the insurance company anticipates making them for a longer period of time.

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How do fixed annuities work?

When you purchase fixed annuities, you send a lump sum or multiple payments to an insurance company. During this accumulation phase, your funds grow at a fixed rate of return. Many fixed annuities are deferred, so this phase can last for several years. But you can also opt for immediate income annuities instead, which can start sending you payouts as soon as one month after your initial contribution.

Often, the interest you accumulate will compound, meaning you’ll earn interest on top of interest. Accounts compound on a set schedule, ranging from monthly to yearly.

When you start taking money from your annuity — the annuitization phase — the amount you receive depends on your interest rates and life expectancy. Accounts with higher annual percentage yields (APYs) often send more per month, while those with lower interest rates pay less. The same is true of life expectancies — the longer you’re expected to live, the lower your payments can be, since the insurer anticipates making more payments.

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Pros and cons of fixed income annuities

Before purchasing a fixed annuity, consider the pros and cons and how they might affect your long-term planning process.

Pros

Guaranteed minimum rates

The minimum guaranteed rate is the lowest APY you’ll receive, and it’s not affected by what’s happening in the economy or market. Without having to worry about market fluctuations, you can anticipate how much money you’ll have as you near the annuitization phase.

Guaranteed income

Payouts from a fixed annuity continue for a set period of time and can even extend to your beneficiaries after you die. Again, a fixed, guaranteed annuity provides certainty. You know how much money you’ll receive and for how long, making it easier to plan ahead. And with a lifetime option, you’ll have protection against running out of money or leaving nothing behind for your loved ones.

Tax-deferred growth

For most fixed income annuities, the money you contribute grows on a tax-deferred basis, so the IRS doesn’t tax earnings as they accumulate.

Instead, you only pay taxes when you start taking distributions, which often happens when you’re in a lower tax bracket during retirement. This is especially helpful to high earners and also allows you to better reap the benefits of compound growth.

Reliability

Unless you choose to make early withdrawals, you don’t have to worry about your principal contributions dropping in value. Since your money isn’t dependent on stock market performance, it generates consistent and dependable income.

Cons

Surrender charges

If you withdraw funds from an annuity before your payout period begins, you may be subject to surrender charges. These fees typically start at a set percentage and will decrease over the lifetime of your annuity. But it’s possible to avoid these penalties, as many annuity contracts will let you withdraw up to 10% per year without incurring additional fees.

Possible tax penalties

If you take money from a fixed annuity prior to reaching age 59½, you’ll be subject to an additional 10% tax penalty. There are a few exceptions to this rule, but they won’t always apply.

Limited liquidity

Because of the aforementioned fees and penalties, it can be costly to take funds out of your account before payout begins. Because of this, you won’t be able to use your money in emergencies or move these funds into higher yielding accounts if a different opportunity arises.

Vulnerable to inflation

Unless you purchase a cost-of-living rider, fixed rate annuities don’t adjust for inflation. Since your payments are fixed at a single amount, the purchasing power of this money can erode over time.

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FAQs

What’s annuity income?

Annuity income refers to the payments you receive from an annuity contract. Fixed income annuities offer consistent and predictable payments, which can work well for those seeking a reliable source of cash after a period of conservative, guaranteed growth.

What’s the downside to fixed income annuities?

While fixed and minimum guaranteed interest rates provide certainty and peace of mind, they also mean that your money might not grow as much as it otherwise would with a more aggressive approach.

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This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.