A fixed annuity is a tax-efficient retirement savings option that can help build predictable assets while you're working. Then, after you decide to retire, it can create a guaranteed stream of income that could last for the rest of your life. Read to find out more about:
What is a fixed annuity?
A fixed annuity is a contract with a life insurance company that is similar in many ways to a bank certificate of deposit. You contribute money to the annuity, either in a lump sum or through multiple payments, to build up the account balance, and the insurer provides a guaranteed rate of return on that principal. Typically, the rate of return is guaranteed for several years at a time (for example, three or five years). After the initial guaranteed period, the insurer will reset the interest rate at regular intervals — usually annually — but the new rate cannot be lower than the guaranteed minimum interest rate in the contract.
How fixed annuities work
Fixed annuities are one of several annuity types, all of which are designed to provide retirement income according to the same basic set of principles: You pay one or more premiums to an insurance company that invests the money to generate returns, which generally grow tax-deferred. When you decide to take income in retirement, the insurance company uses those funds to make regular payments to you for the period of time specified in the annuity contract (e.g., 10 or 20 years), or indefinitely, for the rest of your lifetime.
A fixed annuity (also called a fixed deferred annuity) starts off as a savings vehicle, and you can make contributions either as a lump-sum payment or as a series of contributions. "Nonqualified" fixed annuities don't have IRS-imposed contribution limits, which means you can invest large sums of after-tax dollars without caps, and still take advantage of tax-deferred growth. This period of time — before you start taking income — is known as the accumulation phase.
The distribution (or payout) phase starts when you decide to start making withdrawals, usually at retirement (and there can be tax consequences to withdrawing funds from an annuity before age 59½). If you bought the annuity with pre-tax dollars, withdrawals will generally be taxed as ordinary income — but if you are retired or working less at that point, you'll likely be in a lower tax bracket. If you purchase the annuity with after-tax dollars, you typically only owe taxes on interest earned.
Payout options
You don't necessarily have to convert a fixed annuity into regular income payments in retirement. In most cases, you can choose not to annuitize and receive the entire value of the annuity in one lump-sum payment. However, fixed annuities are generally purchased to provide guaranteed income payments in retirement, which can be structured in different ways. Fixed annuity contracts and terms vary by provider, but payout options typically include:
Period certain: You receive regular (e.g., monthly or quarterly) guaranteed payments for a fixed period of time, such as 10 or 20 years. If you pass away during that period, payments continue to your beneficiary.
Single life: This option can ensure lifetime income by providing regular guaranteed income payments for as long as you are alive. However, once you pass away, the payments stop, regardless of the remaining balance in your annuity account. Many annuities include a death benefit rider that will pass on at least a portion of any remaining balance to your beneficiaries.
Joint and survivor: This annuity covers two individuals, typically spouses, and continues to generate payments as long as one of you is alive. After one person passes away, the surviving spouse continues to receive payments until they pass away. Periodic payments in these annuities are typically lower than for a single life annuity because the insurance company will likely have to continue paying income for a longer period of time.
Benefits of fixed annuities
There are many reasons why people choose these annuities, including:
Dependability: Along with the guaranteed fixed interest rate, your principal (the money you paid to buy the annuity) will stay intact unless you withdraw or decide to end the contract early.
Tax-deferred growth: The interest you earn during the life of your annuity grows tax-deferred, which means you don't pay taxes on the interest until you withdraw it. This can be especially beneficial if you're currently in a higher tax bracket, then begin to make withdrawals later in life when you're in a lower tax bracket.
Compounded growth: All interest that remains in the annuity also earns interest. This is called "compound" interest. This growth can continue for as long as you hold your annuity (subject to age limits).
Guaranteed income: After the first year, you can convert the amount in the annuity into a guaranteed stream of fixed income for a specified period of time — or even for the rest of your life if you choose. Many people choose to integrate fixed annuities into their retirement portfolio to create a reliable "income floor".
Flexible withdrawals: During the accumulation phase you may withdraw the money in your annuity at any time as a single withdrawal, or through scheduled income payments. However, providers may add charges for certain early withdrawals, and there can be tax consequences before age 59½. Once your annuity payments have begun, there is no flexibility to make changes.
Potential downsides of fixed annuities
While fixed annuities can offer stability and predictable income, there are potential downsides to consider.
Limited growth potential: Fixed annuities often have lower return rates than other options like stocks or mutual funds, limiting growth potential for your retirement savings. Also, if interest rates rise after you purchase a fixed annuity, the rate you lock in might result in comparatively lower returns.
Inflation risk: The fixed income from an annuity may not keep up with inflation, potentially eroding purchasing power over time.
Liquidity issues: Early withdrawal from an annuity can come with significant penalties and surrender charges, reducing access to funds for unexpected needs.
How they compare to other types of annuities
There are several annuity types, including fixed, fixed index, registered index-linked (RILA), and variable. Each type offers distinct features and benefits for retirement planning, with varying levels of safety, growth potential, and guarantees.
Fixed versus variable annuities: The primary difference between fixed and variable annuities lies in how the principal grows. A fixed annuity contract provides guaranteed fixed interest rates, and there is no investment risk — you know what your return will be. A variable annuity can allow for greater potential growth by investing in securities similar to mutual funds, but you bear the investment risk and potential for losses. That can lower your income payments when you need money in retirement; conversely, if your investments do well, you could have larger income payments.
Fixed versus fixed index annuities: Fixed index occupy a middle-ground between fixed and variable annuities, offering a blend of risk protection and market-based growth potential. Unlike a fixed annuity that provides a guaranteed interest rate, growth in a fixed indexed annuity is tied to a broad market index. Your returns are based on the performance of this index, subject to a cap and a minimum guaranteed interest rate “floor,” ensuring a minimum return and reducing risk. This means gains are limited to a maximum percentage, and losses are prevented from falling below a certain level, protecting the principal investment. This can provide an attractive balance for those seeking moderate growth without the higher risk profile of a variable annuity.
Fixed versus RILA annuities: A registered index-linked annuity is a relatively new type of product with the potential to provide more upside growth potential than a fixed or fixed-index annuity for people willing to share a measure of downside risk. A RILA annuity ties interest crediting to the performance of a chosen index subject to caps, participation rates, and limits downside losses via a buffer or floor. However, you must accept the possibility of partial losses if the index performs poorly.
Immediate annuities: Unlike fixed annuities that start with an accumulation phase, immediate annuities begin income payments almost immediately after the initial investment (or within a year at most). Also called an immediate income annuity, it is often selected by retirees who have already built up their retirement savings and are seeking a reliable way to generate regular income — like a paycheck or pension payment — that begins right away.
Things to consider before buying a fixed annuity
A fixed annuity could be a good option to supplement your IRA or 401(k) funds and create a guaranteed stream of income in retirement, especially for people who want to lower their exposure to investment risk. If you think a fixed annuity might be the right option for you, here are some things to think about.
How long do you want income payments to last?
Annuities can provide regular, predictable income for a set number of years — or the rest of your life. However, generally speaking, the longer you want payments to last, the lower the amount of each payment.
Death benefits
It's important to consider what will happen to the money in your fixed annuity if you pass away while there's still a balance in your account. A death benefit feature allows you to designate a beneficiary who will receive a specified amount upon your death, either as a lump sum or in the form of continued payments. This can typically be the remaining value in the annuity account or a guaranteed minimum amount, depending on the terms of the contract. Adding a death benefit to a lifetime annuity will result in somewhat lower payments, so review the specific annuity contract terms and consult with a financial advisor to understand the implications and taxes that may affect your beneficiary.
Qualified versus nonqualified annuities:
You can pay for an annuity with pre-tax or post-tax dollars (i.e., income that has already been taxed), depending on your needs. Either way, investment earnings in the annuity grow tax-deferred, but your money is taxed differently as you put funds into the annuity and take payments out.
Qualified annuities are funded with pre-tax dollars, typically through retirement plans like a 401(k) or IRA. Premium contributions aren't considered taxable income for the year they are paid, but when you take income in the distribution phase, the entire amount is typically subject to taxes.
Nonqualified annuities are funded with after-tax dollars, so taxes have already been paid on the contributions. When you take income in the distribution phase, only the investment earnings are subject to taxes.
Surrender charges and fees:
Annuities are not considered liquid investments and typically come with restrictions and penalties for early withdrawal. Be sure to ask about "surrender charges" — fees imposed by an insurance company for withdrawing funds from an annuity contract prematurely. Also, in most cases, a 10% penalty is imposed by the IRS if you withdraw funds before the age of 59½.
Insurance provider integrity
A fixed annuity is a contract between you and an insurance company to provide guaranteed payments designed to last for several years — or the rest of your life. But the guarantees of an annuity are only as strong as the claims-paying ability of the company behind it. Look at the insurance company’s financial strength ratings (FSRs): Independent rating agencies are responsible for gauging the financial strength of companies, and exemplary ratings indicate that a company can honor its financial commitments and pay its claims.
Why people choose fixed annuities from Guardian
An annuity can be an important part of your financial strategy, along with life insurance and other investments. No matter where you are in your retirement planning — or how much you need to save for other life goals — Guardian can help provide guidance to help you retire the way you want and explain different annuity options.
For example, the Guardian Fixed Target AnnuitySM offers a guaranteed rate of return for three-to-10 year periods (all may not be available at all times). You can select the time period that best fits your retirement time frame. We can connect you with a local financial advisor who can explain your options for all types of annuities, review the available tax benefits, and help you decide what makes sense for you.
Frequently asked questions about annuities
Product offerings vary, and a number of factors can affect monthly income payments — in particular, your age (and life expectancy) at the time you start taking income. However, an analysis of over 1,300 annuity products found that an immediate $100,000 annuity purchased at age 60 can be expected to pay approximately $540/month for men and $510/month for women. If purchased at age 65, payments go up to $600/month for men and $560/month for women; at age 70, $680/month for men and $630 for women.1
Financial markets have their ups and downs, bringing about uncertainty. But as you prepare for retirement, reliability may be more appealing to you. Advantages like a dependable income source, tax-deferred earnings, and guaranteed growth can make fixed annuities an attractive investment for people who prefer a guaranteed stream of income in retirement and aren’t comfortable with market volatility.
Like any financial product, annuities have certain characteristics that may not appeal to every person. For one, there is limited liquidity, which limits how much money you can access if you need more than your monthly income allotment. They can also be somewhat complex, especially variable and fixed index products. Finally, annuity fees can be higher than those for other retirement investment vehicles.
A deferred annuity is any type of annuity where you put money in during an accumulation phase and let it grow tax‑deferred; then at some future point you can choose if and how to turn it into income, or just withdraw it. It can be fixed or have other crediting strategies (variable, fixed-indexed, or RILA) which expose buyers to different levels of investment risk. A deferred annuity usually has some liquidity and account value during the accumulation years, and you’re not locked into a specific future payout schedule at the time of purchase.
A deferred income annuity (DIA) is a specific type of deferred annuity that functions like an immediate income annuity, only the payments pushed into the future (i.e., more than one year out). You hand over a premium (often as a single lump-sum payment, but it can be a series of payments) and give up access to that principal in return for a locked-in stream of guaranteed income that starts on a predetermined future date and typically lasts for life (all subject to the terms of the contract). In other words, most deferred annuities emphasize tax‑deferred accumulation with optional future annuitization; DIAs emphasize setting up an assured future “paycheck” now, trading flexibility and liquidity for contractually guaranteed income starting at a specific age.
