What Is a Fixed Annuity Investment?
When you need retirement income, you may face many choices. Your retirement portfolio may include pensions, 401(k)s, savings accounts, stock funds and a myriad of other investment products. Because of the many variables involved in retirement planning, many financial advisers suggest using a fixed annuity. Before you invest in these products, however, understand what you're buying.
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Function
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A fixed annuity is a savings vehicle issued by an insurance company. The annuity is basically a savings account with an insurer. The function of the annuity is to provide you with a savings that you can use for the future. This savings can be paid out in monthly payments, or left in an account for you to draw on as you need it.
Significance
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The difference between a fixed annuity and a savings account is that the annuity account grows tax deferred whereas a savings account is taxed every year on interest earned in the account. The annuity invests in bonds and bond-like instruments in the insurance company's general account. Because of this, the insurance company guarantees your principal and interest on the account.
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Benefits
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You receive guaranteed cash values in the annuity. Because of this, you will know in advance exactly how much money you will have at any point in the future. You also receive the benefit of tax deferral on your savings. A payment can be made to you monthly from the annuity through systematic withdrawals once you're retired. Alternatively, you can annuitize the contract. This means the insurer takes your lump sum savings and turns it into a guaranteed income for the rest of your life or for a set number of years.
Drawbacks
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Fixed annuity contracts tend to pay low rates of return when compared to other investments, since they provide an alternative to bank CDs and provide similar yields. A fixed annuity also comes with surrender charges. A surrender charge is a penalty for cashing in the annuity prior to the maturity date listed on your policy's contract. The maturity specifies how long the insurer invests your money and provides the promises outlined in the contract. Annuitizing your contract is a one-way street. Once you annuitize the contract, you can never get your savings back.
Considerations
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If you have significant savings, a fixed annuity can provide security for your retirement. However, understand that these contracts are long-term contracts designed to help you save money for your retirement and provide a secure place for you to keep your retirement savings once you are retired.
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