How Risky Are Fixed Annuities?
Life insurance companies design and sell insurance products to help you save money for your retirement. One of these products is called an annuity. An annuity is a product that guarantees an income to you for life, or for a set period of time. Fixed annuities are the most basic form of annuity. Make sure you understand the risks of these products before investing in one.
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Types
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There are two types of fixed annuities. Immediate annuities pay an immediate income to you for the rest of your life. They can also pay an income to you for a fixed time period. Immediate annuities may also pay annuity payments to your beneficiary if you decide you'd like payments to continue after your death. A fixed deferred annuity defers the immediate annuity payment. While you are waiting for the payment, the annuity account value grows. The account value represents a savings.
Function
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Fixed annuities invest in bonds or bond-like investments. These investments pay a fixed, guaranteed, rate of return. The fixed rate of return normally does not fluctuate unless it is specified in the contract. This ensures that you will know exactly what your annuity value will be in the future when you first take out your contract.
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Time Frame
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Fixed annuity contracts can be short-term or long-term. Fixed annuities have terms. These terms are called "maturities." Some fixed annuities have maturities of 1 year. Other fixed annuities have 5-, 10- or even 15-year maturities. The maturity of a contract refers to the time it takes before you can liquidate the contract without incurring any penalties from the insurance company.
Warning
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Fixed annuities are subject to interest rate risk. Interest rate risk means that because the interest rate of the annuity is fixed, it is highly susceptible to inflation. If inflation increases beyond the fixed interest paid by the annuity, you will lose real value in your annuity even though the dollar amount in the annuity is guaranteed.
Considerations
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Consider whether you are willing to accept more risk to protect yourself from inflation and reduce the inherent interest rate risk of a fixed annuity. Alternatively, consider short-term fixed annuity contracts to mitigate the interest rate risk of the fixed contract.
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