Understanding Fixed Annuities

Having enough money for the retirement lifestyle you want is usually best accomplished by using all the financial tools at your disposal. Your retirement plan and IRA can provide the foundation for that nest egg. Another tool you may want to consider is a fixed annuity.

What is a Fixed Annuity?
A fixed annuity is a contract issued by a life insurance company under which you give the insurance company a sum of money and the insurance company guarantees to pay you periodic fixed amounts over time. The earnings within the annuity accumulate on a tax-deferred basis until you begin to receive withdrawals. With a fixed annuity, the insurance company usually guarantees a rate of return for some period with the rate being adjusted after an initial period.

Most people use fixed annuities to accumulate funds on a tax-deferred basis as part of their retirement planning strategy. Depending on the policy, withdrawals of interest, or in some cases up to 15% of the principal can be made without penalty. Withdrawals are subject to regular income tax and the IRS imposes a 10% penalty tax if funds are withdrawn before age 59 ½.

There are also annuities that offer payouts beginning immediately. Variable annuities are somewhat similar but offer no return guarantees.

Review the Details

  1. Initial rate guarantee. Compare the initial rate guarantee to other investment options such as government bonds and tax-exempt bonds. Be sure to understand how long the initial rate will last. Some policies offer very attractive rates that only last for a short time.
  2. Subsequent rate re-setting. After the initial rate period, the insurance company will reset the rate. Check to determine what their prior rate setting policy has been. Usually, they adjust the rate based on interest rates at that time.
  3. Fees or commissions. Most fixed annuities are sold without a commission charged to the buyer. The insurance company pays the salesperson and recoups that cost out of their earnings on managing your funds. Do not be afraid to ask the salesperson what he or she will receive. In most cases, it should be less than 5%. Remember, the commission the salesperson received will ultimately reduce the return on your annuity.
  4. Surrender charges. Fixed annuities should be thought of as long-term commitments. Even though in most cases the insurance company is paying interest on your whole investment, there are costs associated with the contract that they plan to recover over time. The contract should spell out how long any surrender charge will last for early withdrawals.
  5. Insurance company. Be sure the insurance company is financially sound and that they have a good customer service history. You want to make sure they will be able to fulfill their guarantees. You should be able to get a ratings report from the salesperson or at the public library.

Fixed annuities can be a valuable part of your total financial strategy, but they are not for everyone. They offer the benefit of tax deferral and come with the guarantee of the insurance company. Be sure to investigate all of the details before signing up. Compare the rates, understand all the charges and make sure the insurance company is financially sound.

This information has been provided by Financial Wisdom Marketing Services, Inc. and is for educational purposes only.  Content from Financial Wisdom and/or Redwood Credit Union is not, in any way, intended to provide legal, tax, or financial advice.