There are countless options to consider when planning for retirement. IRAs, 401(k)s, pension plans, and Social Security may all factor into your long-term goals. Annuities have also become popular in recent years, and for good reason. They’re great tools for protecting investments and ensuring supplemental income during retirement. Let’s explore some of the major pros and cons of a fixed annuity.
What Is a Fixed Annuity?
Annuities come in various forms. Their rates are either fixed or variable, and they may also be classified as traditional, indexed, multi-year guaranteed, deferred income, or single premium immediate. However, all annuities share some common themes. Insurance companies generally contract these financial products to accumulate value from interest over time.
Traditional fixed annuities are some of the simplest types of annuities available. They’re most popular among savers, not investors or speculators, and they’re designed to supply guaranteed retirement income throughout one’s remaining years. A fixed annuity is like a certificate of deposit (CD), but it’s provided by an insurance company rather than a bank or credit union. It’s also more flexible than a traditional CD. With a fixed annuity, the insurance company promises to pay out a fixed percentage of the principal investment each year or via a lump sum.
Pros of a Fixed Annuity
Retirement planning involves a great deal of cost-benefit analysis. With any investment, it’s essential to carefully consider your individual long-term goals before making any decision. Luckily, there are many benefits of a fixed annuity worth noting.
Principal Protection
Investing can be a risky business. However, a fixed annuity is one of the safest bets you can make. Highly rated insurance companies generally have no issue guaranteeing the security of your principal investment. They assume all risk, they follow strict regulations from governing state bodies, and the only way you’ll lose your investment is if they go bankrupt. That’s why it’s so important to only work with an A-rated (or better) insurance company with a proven record of satisfied clients.
Guaranteed Returns
Many people are attracted to fixed annuities for the returns they deliver. They often provide greater peace of mind than many other retirement opportunities. Once a fixed annuity’s minimum conditions are met, the insurance company agrees to pay out a consistent amount for the rest of your life. Also, this fixed income isn’t subject to change due to stock markets swings or shifting interest rates.
Tax Deferral
Fixed annuities can also reduce opportunity cost associated with capital gains taxes. Because they’re tax-deferred, any funds placed into them grow tax-free until they’re withdrawn. When paired with a maximally funded IRA or 401(k), a fixed annuity can be a key part of any long-term, tax-free saving strategy.
Cons of a Fixed Annuity
A fixed annuity is a major investment, and it won’t be ideal for everyone. Inflation, liquidity, and retirement age are all crucial factors to consider in this regard. Plus, annuities can be intimidating, especially for those new to retirement planning. Here are a few disadvantages to keep in mind.
Illiquidity
Annuities are long-term assets, and they can be expensive. To receive their maximum benefits, you must lock up a sizeable principal investment for several years. This can significantly restrict liquidity throughout the contact’s entire lifetime. However, it’s often possible to withdraw some or most of a principal investment during the initial accumulation period (for a fee).
Hidden Fees
Some fixed annuities involve various hidden charges. Insurance companies may charge fees for commission, subaccounts, account riders, inflation protection, mortality and expense, or contract maintenance. Furthermore, most annuities carry some form of surrender or early withdrawal penalty. Some are also subject to market value adjustments (MVAs) according to changing interest rates.
Low Rates of Return
While a fixed annuity can guarantee a steady annual income, it’s unlikely to produce a significant return on investment. Typical fixed annuity rates range from about 3.5% to 4.6%, depending on the length of their surrender period. In some cases, annual inflation and the rising cost of consumer goods may outpace their returns.
Ask Us about a Fixed Annuity
Retirement planning doesn’t have to be stressful or intimidating. Our professional agents are always available to walk you through the process and answer any questions you may have. If you’d like to learn more about the pros and cons of a fixed annuity, we welcome you to contact us for more information today.