How to Choose a Fixed Annuity

A fixed annuity is a fairly straight forward investment. It is essentially a contract between an individual and an insurance company. The investor agrees to give a specified amount of cash to the company in exchange for guaranteed future payments for the period agreed to. It is a safe way to have a predictable income. The contract calls out the interest rate paid on the principal, the starting date of the payments and the length of time the payments will be made. Here's how to choose the fixed annuity that suits your needs.

Instructions

1. Understand that the invested cash grows tax deferred until payments begin. The longer the period between the time of the investment and the beginning date of payments, the more interest that will add to the account and the higher the payments will be. Each payment (called the annuitization) will be part return of capital and part interest income, taxed at the recipient's (called the annuitant) regular income tax rate.

2. Realize that there are three ways to receive payments. In a lump-sum annuity, the annuitant gets a single payment at the end of the contract which includes the principle and the agreed amount of interest. In a fixed period annuity, the annuitant gets a series of monthly payments (a 10 year period, for example). In a lifetime annuity, the annuitant receives payments for as long as she lives.

3. Consider that a fixed annuity is similar to a long term CD, in that, like a CD, money grows at a specified interest rate, guaranteed for the period the money is held by the insurance company. The way to decide whether a fixed annuity is a good choice is to decide whether it's better to get a guaranteed amount ( a safe, secure investment) or whether you could do better by investing the same amount yourself and taking a chance on the ups and downs of the market over the same period of time (a riskier choice where you would have to make investment decisions during the period).

4. Know that the decision regarding a fixed annuity involves many factors. The money will be tied up for the period of the contract, it is not very flexible, and the interest rate (though guaranteed) will usually be a conservative rate. If the market goes down during the annuity period, this benefits the annuitant, but if the market goes up significantly, the insurance company benefits. In addition, in the case of a lifetime annuity, once the annuitant dies, the payments cease, and no money goes to the annuitant's heirs.