How Does a Fixed Annuity Work?

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A fixed annuity is an investment product contracted with an insurance company offering you a guaranteed payout in the future. Fixed annuities offer many benefits when planning your retirement, but it’s essential to understand how they work. Reviewing the contract terms, including accumulation requirements and payment schedules, can help determine how a fixed annuity might fit with your retirement plans. Learn what a fixed annuity is, how it differs from other annuity types, and what to expect when you add one to your investment portfolio.

What Is a Fixed Annuity?

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A fixed annuity is a contract you purchase from an insurance company that provides you with a guaranteed monthly income at a later date. Fixed annuities are flexible, customizable, and have lower risk than other investment options, making them a good choice for investors nearing retirement.

Fixed annuities differ from other annuity types primarily due to their guaranteed income. A variable annuity, for example, allows you to collect monthly payments in retirement, but how much you earn depends on market performance. If the market performs poorly, you won’t earn as much with a variable annuity. A fixed annuity allows you to plan for retirement with a set rate of return.

How a Fixed Annuity Works

Learning how a fixed annuity works can help you decide if it’s the right investment type for your financial goals. Here are a few essential things to know about fixed annuities.

Contract Terms

A fixed annuity is a contract between you and your chosen insurance provider that guarantees you a set rate of return. Fixed annuities are also available from banking institutions, financial service companies, and brokers. Insurance companies take the invested funds and reinvest them into other markets. The insurance company accepts the risk, promising to pay the difference in your promised rate, even if they lose money.

Initial Investment

When purchasing a fixed annuity, you can choose how much you want to invest initially. Some investors may purchase a fixed annuity with a lump sum of cash, whereas others may fund their annuity through regular, monthly payments. Your investment requirements vary, depending on your contract.

Your initial investment period is referred to as the accumulation phase. During this phase, you’re expected to fund your annuity. The payout phase follows the accumulation phase when your contract promises to begin issuing payments.

Payout Timeline

Your payout timeline also depends on your fixed annuity contract. Some fixed annuity contracts pay for a set number of years, whereas others issue monthly income payments for life. While less common, other annuities even offer the option for a large lump sum payment once your contract matures.

Fixed annuities also tend to be more flexible than other annuity types. Some fixed annuity contracts may not even require setting a payout date. Instead, if you meet the minimum accumulation phase requirements, you can notify the insurance company when you’re ready to begin collecting.

Payout Amount

Like the initial investment, your payout amount depends on your contract. The great thing about fixed annuities is that they offer a fixed rate of return that’s not reliant on market performance. When you begin collecting annuity payments, you’ll receive the amount you agreed to when first purchasing the contract.

Payouts on fixed annuities are usually listed as a fixed interest rate. This interest rate is how much you’ll earn on your investment, and it won’t change. You’ll still receive the same interest rate if the stock market does well or underperforms. This predictability can make fixed annuities an excellent option for people nearing retirement. With a fixed annuity, you don’t have to worry about losing your savings just before you retire.

Another benefit of a fixed annuity is that some contracts have beneficiary benefits. If your annuity payouts outlive you, they can transfer to your beneficiary free of probate.

Tax Obligations

It’s essential to plan for taxes with any investments you consider. Fixed annuities are tax-deferred, which means you’re not obligated to pay taxes on your earnings until you collect them. During the payout phase, you’ll pay a tax rate based on your income at the time. If you wait until retirement to collect your fixed annuity payments, your tax obligations may be lower if you no longer work. Also, you can benefit more from accumulated and compounding interest, since you don’t pay taxes until you withdraw your funds.

Fixed annuities offer many advantages to those planning for retirement. In return for purchasing a fixed annuity through an insurance company, you can supplement your retirement income with guaranteed monthly payments. Adding a fixed annuity to your financial plans can help minimize the risks of other investments and help you enjoy a comfortable retirement.

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