The fixed annuity is a contract with a life insurance company that provides income for those in retirement. The product allows the policyholder to make a one-time deposit that will grow to provide tax-deferred income later. The insurance company guarantees a fixed interest rate that you will earn on the money deposited into the annuity contract. There are two main types of fixed annuities: deferred and immediate.
Basics of Fixed Annuities
A fixed annuity is very similar to a certificate of deposit (CD) issued by banks or other financial institutions. Except with a fixed annuity, the interest you earn inside the annuity accumulates and is not taxed until you withdraw it from the annuity fund. With a CD, the bank sends you a 1099-INT tax form each year reporting the amount you earned in interest. You must report this interest on your tax return even if you let it accumulate in the CD.
Like a CD, a fixed annuity pays a guaranteed return. Sometimes the return is front-loaded, so you may have a higher interest rate in the first year and a lower rate in the years from the second to the tenth. Like a CD, there is a specific term, such as a five-year fixed annuity. Some fixed annuities have terms of up to fifteen years. If you surrender the annuity before the term is up, you will incur surrender charges.
Different insurance companies will offer products with varying interest structures. Don’t get caught up in the interest rate for the first year. You should calculate the return the product provides if held for the entire contract duration to accurately compare offers.
If you have a long timeline and want to invest with no risk, you may choose a fixed annuity over a CD to defer taxes and potentially achieve a higher interest rate than banks offer. This can be a good option for inherited money or a bonus you receive.
Deferred Fixed Annuity
With a deferred fixed annuity – also known as a deferred income annuity (DIAs) – you receive a guaranteed amount of interest that accumulates within the annuity contract. The interest is tax-deferred, so no taxes are paid on the income until you withdraw it.
You can purchase a deferred fixed annuity using IRA funds; in this case, the tax rules that apply to IRAs will govern all funds in the annuity. These rules include contribution limits, the type of investment held, and required minimum distributions (RMDs). You can also buy the deferred annuity using non-qualified funds (non-IRA money).
Withdrawals from Deferred Fixed Annuity
Withdrawals made before age 59 and a half may be subject to penalties in addition to income taxes. Also, when you need to withdraw money, interest is withdrawn first before principal.
Once you have withdrawn all the interest accumulated over the years, you will start withdrawing principal. This amount is a return of what you put in – your cost basis. Withdrawals of principal are not subject to taxes. Most deferred fixed annuities contain a feature that allows you to access up to 10% of the contract value each year without incurring surrender charges.
If you are looking for the highest interest rate, you can compare deferred fixed annuity rates with alternatives that may offer more flexibility, such as certificates of deposit, or a ladder of high-quality bonds that allow you to keep your principal with minimal restrictions on accessing your money.
Income Rider Benefits
Many deferred fixed annuities offer additional benefits beyond the guaranteed return. For example, they may include a guaranteed income rider. This provision – the rider – specifies a set amount of retirement income that can be paid to you after ten or twelve years in the future.
With
This type of product is purchased to guarantee a certain outcome or future income. Now, it’s not about achieving the highest rate of return; it’s about ensuring that you have a minimum guaranteed amount of income for your retirement years.
Deferred fixed annuities with income riders can be suitable for those who are about ten years away from retirement. If the market drops close to your retirement date, it won’t matter. This product guarantees the future income that will be paid to you regardless of what the market is doing.
Immediate Fixed Annuity
Immediate annuities are marketed as “lifetime income” products. They pay a specified amount each month for a set period, such as 10 or 20 years. You can also purchase a life annuity that provides lifetime income and joint life options that may include a second person’s life. Some options allow for any unused funds to be directly returned to your heirs.
With an immediate fixed annuity, you exchange your lump sum of money for a guaranteed income payment from the insurance company that starts immediately. You may have inherited a large sum or sold a business; you can use that money to buy the immediate annuity. These products are called single premium immediate annuities (SPIAs). Once the annuity payments begin, they do not change unless you purchase an annuity that adjusts for inflation.
Once the annuity payments start, you no longer have access to the capital. Instead, you have the right to the income promised to you by the insurance company. The insurance provider uses life expectancy projections and statistical tables to determine how much income it can pay based on your large deposit.
You will choose the duration of your payments, such as guaranteed income for ten years or for your entire lifetime. An immediate fixed annuity can be a suitable addition to your retirement plan if you are:
- Retired or plan to retire soon
- Want to ensure that more of your expenses are covered by guaranteed income
- Prefer safe investments and are anxious about risk
- Single or have recently become a widow
- Concerned about spending your money too quickly
Source: https://www.thebalancemoney.com/how-does-a-fixed-annuity-fit-your-retirement-plan-2389021
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