Features Common To Fixed Annuities
There are several common fixed annuity features that benefit the policy owner, including guaranteed return of principal and income options.
Guaranteed Rate of Return:
Fixed annuities offer a guaranteed rate of return over the life of the contract. These contracts offer a rate of return that is competitive with CDs of a similar time frame. Fixed annuities make up the vast majority of all annuity sales. This is because safety of principal the main concern for many retirees.
Your principal is guaranteed with fixed annuities (assuming the insurance company remains solvent), and you know the exact amount of growth for the duration of the contract. This is ideal for retirement planning. An investment of $100,000 in a 10 year guaranteed fixed annuity rate with a 4% rate will return $48,021. Other investment vehicles to offer such certainty are bonds, CDs, and treasuries, but often at lower overall yields and without the benefit of tax-deferral.
The interest earned on a fixed annuity is not subject to current taxation until it is withdrawn from the contract. This allows for a potentially greater cash buildup than if income taxes were paid on accumulating interest as earned. This can substantially increase the yield of the investment in comparison to vehicles like CDs and bonds in which the taxes on growth are due each year. For detailed examples of tax-deferral in action, see Fixed Annuity Performance. To be fair, there are certain types of specialized CDs and securities, such as money market mutual funds, that feature tax-deferral, but none offer the same set of ancillary benefits for retirees as fixed annuities (like lifetime income).
Security of Principal:
With the exception of CDs, money market accounts, and fixed annuities, no other investment guarantees zero potential loss of principal. But unlike CDs and money market accounts, fixed annuities typically offer higher rates and tax deferral. To be clear, this does not make annuity investment risk-free, but it does eliminate the most undesirable form of risk for retirees who are more concerned about the safety of their money than a higher rate of return. With a fixed annuity, unless the insurance company completely collapses, the worst-case scenario is a lower-than expected return; never a loss. This protection is critical for any retirement savings strategy to succeed.
Perhaps the most unique and useful feature available with annuities is the lifetime income option. Consider the following example of how a Lifetime Income Annuity might work: If you’re a 65-year old male and you purchase a Lifetime Income Annuity with a premium of $100,000, you might receive payments of $697 per month, or $8,364 per year, for the rest of your life. And because this non-qualified annuity was purchased with after-tax dollars, only $3,372 of that annual income would be taxable. The remaining $4,992 would be treated as a return of your principal, which you would receive tax-free for approximately the next 20 years. Thereafter, the income payments are fully taxable.
For all Lifetime Income Annuities, the factors that determine the amount of payments you will receive include:
- The amount of your premium and the interest rate environment when you purchase your policy.
- The number of lives the policy covers (either one or two).
- Your age and gender (and those of the other person, for Joint Life policies).
- Any guaranteed minimum payment, inflation protection, change in income schedule, or legacy options you select.
- The frequency with which you choose to receive your income payments (monthly, quarterly, semi– annually, or annually).
- The date on which your payments are scheduled to begin.