What is a fixed annuity?
Fixed Annuities are Tax-Deferred Policies intended for Retirement Planning. Depending on your needs, you can either buy a Single Premium annuity, which enables you to purchase the policy with a single lump sum, or a Flexible Premium policy, which enables you to add to your annuity as often as you’d like.
With a Fixed Annuity, your money goes to work for you immediately, earning tax-deferred interest on the premium payments you make. Fixed Annuities offer guaranteed interest rates that are fixed by the insurance company for a set period of time (one, three, five-even ten years), depending on which annuity con-tract you select. After the initial Interest Guarantee Period ends, you will earn a Renewal Interest Rate, typically set annually by the insurance company. This rate is influenced by market trends and is generally guaranteed to remain at or above 3%.
Fixed Annuities have two phases. After an Accumulation Period (when you put the money into your annuity), you begin the Payout Phase. One advantage of Fixed Annuities is that you determine how long these two phases last. The accumulation phase can range from months to years, and the payout phase allows you to structure your payments either as a lump sum, or as a series of payments over a period of years-depending on your needs.
The majority of Fixed Annuities have No Front-End Loads or Charges, but most carry some kind of penalty for early withdrawals or surrenders. These Surrender Penalties vary from policy to policy, so consider how much liquidity you might need before choosing an annuity. Generally speaking, the longer the surrender fee period you select, the higher your interest rate.
Is an annuity right for me?
Penalty-free withdrawals are an important feature of the fixed annuity. Most annuity companies allow you a certain amount of penalty-free withdrawals each year. Interest only and 10% are common, but some companies offer free withdrawals as high as 15% of your principal and interest. This may be an important consideration if liquidity is a concern. Because taxes may be due on withdrawals from your annuity, you may want to discuss withdrawals with your tax advisor.
Guaranteed Principal is another important fixed annuity feature for many people. Fixed annuity policies that offer this feature promise the company will return 100% of your original premium payment (principal), even if you elect to terminate your annuity policy early. If this feature is important to you, ask your advisor to show you policies with a guaranteed principal feature.
HOW DO I KNOW IF FIXED ANNUITIES ARE RIGHT FOR ME?
Fixed annuities meet a wide range of needs, but they aren’t for everyone. If you are looking for immediate, unfettered access to your funds, a bank account may be a better choice. If you want to participate in the equity market and are willing to assume greater risk, fixed interest rate annuities may not be for you.
However, if you are looking for an excellent retirement planning tool that affords you tax benefits, flexibility, and safety, a fixed annuity is likely to suit your needs and objectives. Fixed annuities can play an important role in just about anyone’s retirement planning. How large a role fixed annuities will play depends on many factors, including your age, the amount of time you have to accumulate assets, and other factors your advisor can review with you.
Benefits of owning a fixed annuity
Tax-deferral is one of the great advantages fixed annuity products have over most bonds, bank certificates of deposit, and mutual funds. The interest earned on your annuity is tax-deferred, therefore your money grows faster than it would in a taxable fund. As long as you keep your funds in the annuity, taxes are deferred. When you begin withdrawing funds, the interest portion becomes taxable.
The IRS considers your first withdrawals interest, but your principal generally is not taxable in a non-qualified plan (different rules apply to annuities in a qualified plan like an IRA). Withdrawals of interest income before age 50 1/2 may be subject to a 10% federal income tax penalty. For more details, you should go over the tax situation with your tax advisor.
Safety is another important feature of the fixed annuity. Most life insurance companies, known for their conservative business practices, will guarantee your principal and a minimum interest rate. Ask your agent about working with life insurers and the protections afforded you.
Flexibility attracts many individuals to fixed annuities. You decide how you want to pay (in a lump sum or in a number of smaller deposits that fit your schedule); you decide how you want to be paid (in a lump sum disbursement on a fixed date or in a series of payments); and you decide how the annuity will be handled after your death. Unlike other financial instruments, a fixed annuity is able to provide you with a guaranteed income for the rest of your life-an income you cannot outlive.
Avoiding Probate is another advantage many fixed annuities offer. Typically, when annuity death benefits are paid to a beneficiary, other than an annuitant’s estate, the family can avoid the emotional and financial drain caused by probate.