Reading Time: 7 minutes Don’t Get Burned by Market Volatility: Consider Fixed Annuities
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Are you starting to think about your retirement years and how you’ll generate a steady stream of income? If so, you’re not alone.
Many people enter their golden years concerned about having enough money to live comfortably without sacrificing their lifestyle. One potential solution to this problem is fixed annuities.
In this blog post, we’ll explore what fixed annuities are, how they work, and why they might be the right choice for you.
Table of Contents
What Is a Fixed Annuity?
Fixed annuities are a type of insurance contract that guarantees a specific rate of return on your contributions. This rate is fixed for a specific period of time, usually ranging from 1 to 5 years.
You contribute a certain amount to the annuity, and the insurance company invests your funds in conservative investments, such as bonds.
At the end of the contract term, the insurance company returns your contributions and the accrued interest.
Fixed annuities are categorically different from other types, such as variable and indexed annuities.
Variable annuities are more unpredictable because the rate of return depends on the underlying investment’s performance.
Indexed annuities, on the other hand, offer higher returns but with the risk of losing your principal if the market performs poorly.
A fixed annuity is an insurance-backed contract that offers a fixed rate of return.
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Fixed annuities are sometimes compared to a certificate of deposit (CD), except you purchase an annuity from an insurance company rather than a banking institution.
The most appealing aspect of a fixed annuity is the opportunity to collect guaranteed monthly payments in retirement.
Who Should Consider Fixed Annuities?
Fixed annuities are perfect for those who expect a guaranteed rate of return regardless of the market conditions.
They are also suitable for conservative investors seeking to preserve their principal while generating a steady stream of income in retirement.
Benefits of Fixed Annuities
Fixed annuities have the following benefits:
Guaranteed Interest Rates
The primary benefit of fixed annuities is the guaranteed rate of return. You know how much interest you will earn and can plan accordingly.
This guarantee is especially attractive in periods of market uncertainty and volatility.
Principal Protection
Since the insurance company invests the funds in conservative investments, you are protected from market volatility. Your principal investment is not affected by any fluctuations in the stock market.
Retirement Planning
Fixed annuities provide an excellent source of retirement income. You can receive a lump sum payment or a monthly income stream during your retirement years, thus providing financial security and peace of mind.
Estate Planning
Fixed annuities, like most annuities, typically have a death benefit. A death benefit ensures that in the event of your passing, your loved ones can still receive the remainder of your annuity payments.
When you purchase a fixed annuity, you can designate a beneficiary to inherit the remaining payments after your death.
Drawbacks And Risks of Fixed Annuities
Some of the drawbacks to fixed annuities are the following:
Fees
Some fixed annuities come with high fees and charges, including administrative fees and surrender charges.
It’s important to review the fee structure of any fixed annuity you’re considering and make sure you understand how fees will impact your returns.
It is essential to be aware of these costs before investing.
Limited Potential for Growth
While fixed annuities provide a reliable and steady rate of return, they also have limited potential for growth compared to other investment options like stocks or mutual funds.
Lack of Liquidity
Fixed annuities often come with surrender charges, which means you may face hefty fees for withdrawing funds before the end of the contract term.
If you anticipate the need for access to your funds before the contract term ends, a fixed annuity may not be the best option.
Inflation risk
Fixed annuities typically offer a fixed rate of return, and the interest earned may not keep up with inflation.
Other investment options may be more suitable for those concerned about inflation eroding their purchasing power.
Tax Implications
Fixed annuities are tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw them.
But once you withdraw the funds, they will be taxed as ordinary income, which can impact your tax bracket and overall tax liability.
How To Purchase a Fixed Annuity
Purchasing a fixed annuity can help you achieve your retirement goals. However, choosing the best retirement products requires research and a basic understanding of fixed annuities.
You can purchase a fixed annuity with the following steps:
1. Conduct Research
Before purchasing a fixed annuity, ensure it’s the right financial tool for your goals. Fixed annuities offer a guaranteed rate of return and are often used to generate income during retirement.
Reviewing your current finances and retirement goals is a great way to determine if a fixed annuity is right for you.
Speaking with your Financial Advisor and using a retirement calculator can help identify your financial needs.
Consider how much money you have to contribute to an annuity now and how you prefer to receive returns in the future.
Most fixed annuities allow you to collect a large lump sum or monthly payments once your contract matures.
Researching how a fixed annuity fits your retirement goals also includes tax planning. The earnings from a fixed annuity are tax-deferred, which means you will only owe taxes once you begin receiving payments.
2. Compare Annuity Rates
The next step to purchasing a fixed annuity is to compare available rates. Fixed annuity interest rates fluctuate rapidly, with current average rates around 5.5%.
The fixed-rate you receive will depend on a few factors, including contribution amount and term length. Shop around to find the best rates and most reputable providers.
Ensure your chosen provider is appropriately licensed and has a good track record.
3. Select Annuity Provider
A fixed annuity offers a fixed rate of return, which means the insurer’s ability to pay is the most significant risk of losing money. Fixed annuities are typically considered low to moderate risk.
It’s crucial to choose an insurance company provider with a strong rating.
An insurer rating refers to the financial stability and reputation of the company backing the annuity.
Reviewing AM Best ratings is a great way to determine the quality of an annuity provider, with A++, A+, A, and A- being the best ratings.
It’s important to note that the federal government doesn’t regulate fixed annuities.
Instead, individual state guaranty associations are in charge of overseeing annuity providers, which means requirements and protections vary among states.
4. Complete the Annuity Application
Most annuity providers require you to fill out an annuity application, which includes your legal name, contact information, and contribution amount.
You can also name a beneficiary, which is the person who may take over your annuity if it outlives you.
This is also an excellent time to ensure you understand the details of the annuity. Evaluate the contract length, including how much and when you can expect to receive returns.
Ensure you also understand all associated fees and risks with the fixed annuity you choose.
Fixed annuities tend to have lower fees than variable annuities, but it’s still important to plan to understand the costs.
5. Fund the Annuity
Most annuity providers accept funds in multiple forms, including via checking accounts, savings accounts, or retirement funds.
Once received, you must transfer the initial contribution to your chosen brokerage account.
You’ll also have to decide if you want to fund your fixed annuity with a one-time lump sum payment or through flexible premium payments over a long period.
6. Review Your Annuity
Most annuities come with a free look period, which allows you to request a refund if you decide it’s no longer for you. The free look period is usually less than 30 days, with many only allowing up to 10 days.
So, understand your options and explore the annuity in detail before this period runs out. During this time, ask any questions and review the listed fees.
When is a Fixed Annuity Not Suitable?
While fixed annuities can be an excellent option for many investors, they are only suitable for some.
While fixed annuities can be a great investment option for some, they may not be suitable for everyone.
Here are some instances when a fixed annuity may not be the best investment option:
Young investors
Fixed annuities may not be the best investment for young investors as they have a longer time horizon and can tolerate more market volatility.
They may benefit more from investing in growth stocks or mutual funds.
Higher Risk Tolerance
If you have a higher risk tolerance and desire a higher return on your investment, fixed annuities may not be the best option for you. Instead, look into variable annuities or indexed annuities.
Need for Liquidity
Fixed annuities often come with surrender charges, which means you may face hefty fees for withdrawing funds before the end of the contract term.
If you anticipate needing access to your funds before the contract term ends, there may be better options than a fixed annuity.
Inflation Risk
Fixed annuities typically offer a fixed rate of return, and the interest earned may not keep up with inflation.
Other investment options may be more suitable for those concerned about inflation eroding their purchasing power.
Conclusion
Fixed annuities are an excellent investment option for conservative investors seeking a guaranteed rate of return and principal protection.
They provide a dependable source of retirement income while also mitigating risks associated with market volatility.
However, it is essential to consider fees and tax implications associated with fixed annuities before investing.
Ultimately, your investment goals, risk tolerance, and financial situation should dictate the decision to invest in a fixed annuity.