An annuity is a contract between you and an insurance company that helps you grow your savings. You can make a lump-sum payment or contribute over time, and your funds accumulate interest. When the account matures, the insurer sends you one or several payouts.
If you purchase a fixed annuity, the insurer takes on all the market risk. Regardless of market conditions or interest rate changes, the insurer has to give you agreed-upon payouts.
Keep reading to discover how insurance companies assume the market risk with a fixed annuity contract.
What’s a fixed annuity?
With fixed annuities, the insurance company guarantees steady returns on your annuity. They offer the same interest rate for the entire contract term, which makes these accounts a predictable way to save.
First is the accumulation phase, where you send the insurer one or several contributions, and your money grows tax-deferred. Then comes the annuitization phase, when you start receiving regular payments. An immediate fixed annuity disburses funds as soon as 30 days from your final contribution, while a deferred account begins payouts at a future date.
When it’s time to receive distributions, you can choose from several payout options to fit your financial goals. These include a guaranteed lifetime income stream, payments for a specific number of years, or a lump-sum withdrawal if you prefer access to your funds all at once.
Are fixed annuities safe?
Fixed annuities are among the safest financial products, offering reliable and secure income. The insurer bears the market risk with a fixed annuity contract, protecting your original deposit (the principal) and any interest you earn — even if the insurer’s investments don’t perform well.
To further secure your annuity, check the insurer’s financial strength by reviewing ratings from the following five agencies: AM Best, Fitch, Moody’s, S&P Global, and Kroll Bond Rating Agency. Insurance companies that earn an A- rating or higher are most likely to meet their financial commitments.
You will need to manage a few risks with annuities, but they’re generally minor. For instance, inflation may reduce the purchasing power of your payments over time, and early withdrawals could result in fees and penalties. But the overall security fixed annuities provide outweighs these concerns.
How do companies mitigate fixed annuity risks?
Insurance companies use innovative strategies to protect your fixed annuity — here’s a closer look at how they do it.
Careful planning
Insurers time their investments to mature by the time they need to pay you. This strategy protects your money from market ups and downs because the insurer doesn’t need to sell investments to start distributions. Instead, they maintain a steady cash flow to ensure you receive your funds on time.
Conservative investing
Insurance companies prioritize conservative investments to minimize risk while growing at a predictable pace. They invest in stable options such as high-quality corporate bonds, government-backed securities, and select real estate. These accounts offer steady returns, protecting your principal from significant market changes.
Diversification
Insurance companies keep your fixed annuity safe by spreading your funds across various markets and assets. If one investment underperforms, profits from others help offset the loss.
Fixed annuity pros and cons
Fixed-income annuities can be a valuable part of your financial plan, but like any financial planning option, they have advantages and disadvantages to consider. Here’s a breakdown.
Pros of fixed annuities
Tax advantages
Most fixed annuities allow your earnings to grow tax-deferred, so you won’t pay taxes until you begin withdrawing your income. This leaves more money in your account to accumulate interest, growing your funds faster. And since you only owe taxes when you start receiving payments — often during retirement — you may be in a lower tax bracket, so you’ll likely owe less.
Reliable income
Annuity contracts outline your payment options in advance, so you’ll always know how much income to expect. Here are a few ways you can receive funds:
- Single-life payments provide income for as long as you live.
- Joint-life coverage ensures payments continue for you and your spouse until you both die.
- Fixed-period distributions guarantee payments for several years, even if you pass away. The beneficiary can either receive a refund of the remaining principal or continue receiving payments until the term expires.
- Specified withdrawals allow you to decide how much money you want to receive until the fund's payments end.
If these options don’t suit your financial needs, your insurer may offer other payout methods.
Stable value
Fixed annuities are typically considered to be good savings choices, as they can be stable, stress-free options for building financial security. These annuities offer dependable growth and principal security. And thanks to a guaranteed minimum interest rate, market ups and downs won’t affect your earnings like they would with indexed annuities.
Cons of fixed annuities
Liquidity challenges
Early withdrawals typically incur surrender charges of around 10%. But most fixed annuity contracts allow you to withdraw up to 10% per year without penalties, giving you access to some funds while keeping your annuity intact. Careful planning helps you balance liquidity needs with long-term stability.
Inflation risk
Inflation reduces the purchasing power of your payments over time, but you can choose annuities or riders with inflation protection. These annuity options usually provide a lower income initially, but payouts will keep pace with inflation.
Growth limitations
Fixed annuities lock your returns in at a set rate, so even when the market booms, your earnings won’t increase. While your money remains safe and grows steadily, it won’t match the gains you could earn from investments like stocks or mutual funds during strong market years. It’s a trade-off: You typically gain security and predictability but might miss out on higher earnings when the market performs well.
This communication is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice.
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