A fixed annuity is an investment product created and issued by insurance companies. In exchange for a deposit, investors receive fixed, scheduled interest payments. The duration of the payments is determined by the type of fixed annuity. Some annuities make payments for the life of the annuitant, others for a specified term, while others offer payments to surviving beneficiaries as well. Fixed annuities have both pros and cons, and may be more appropriate for some investors than others.
Interest Payments
One of the main benefits of a fixed annuity is the promise of a consistent and set income stream. In periods of falling interest rates, the set payment of an annuity can be an attractive investment, as the fixed payment will remain at a higher rate than otherwise available in the market. However, the converse is true in periods of rising rates, where higher rates of return are available from alternative investments.
Safety
Fixed annuities carry a guarantee of the safety of principal and interest, making them safer than investments such as stocks, which carry no guarantees. However, the safety of a fixed annuity is dependent upon the financial strength of the underlying insurance company. While fixed annuities may act in many ways, such as a bank certificate of deposit, CDs carry federal insurance, whereas annuities do not.
Fees
Fixed annuities usually have fees attached by the issuing insurance company. The most notable is the surrender fee, which charges investors a percentage of assets if the annuity is sold within a specified time frame, often six years or more. The surrender charge generally declines for every year that an investor holds the annuity, but may start at 7 percent or more. In addition, some types of fixed annuities charge additional mortality and expense fees.
Taxation
Annuities are deemed tax-advantaged investments by the Internal Revenue Service, ITS, so no taxes are due on any accumulations in an annuity before they are paid out. Upon distribution, the earnings within an annuity are taxed at ordinary income tax rates.
Penalties
As with an IRA, 401k, or other tax-advantaged investment account, the IRS levies a 10 percent early withdrawal penalty on any annuity distributions taken before you reach age 59 1/2. In addition, once you reach age 70 1/2, the IRS requires you begin taking annual minimum distributions from your annuity or pay a 50 percent penalty on the amount not distributed.
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