A Fixed Annuity is a contract between you and an insurance company. In exchange for a deposit, known as a current premium, your insurer agrees to pay you a minimum fixed rate of return. Generally rates change annually.
If desired, this policy could be annuitized and provide a future stream of income for a set period of years, or for a lifetime.
Don't assume fixed annuities are old fashioned and not an option for current investors, they were and still are very flexible financial accumulation vehicles. However, not all contracts are exactly alike.
Policies allow you to pay your premium in a single lump sum, or you can pay it over time with automatic monthly checking account drafts, maybe deposits once or twice a year suit your cash flow better. It really is up to you and the product you choose.
You and your product chosen will specify when you would like to begin receiving the income from your annuity, if ever. You can start your income stream immediately or you can let your annuity accumulate to eventually pass to heirs without ever having withdrawn any monies.
Fixed annuities are allowed to grow tax deferred. You do not have to pay taxes on any growth of your annuity until withdrawn. Depending on your time frame, liquidity needs, present and future tax brackets, these could be a good portfolio alternative.
Immediate Fixed Annuities
Do you desire an income stream that is guaranteed? Then an immediate annuity with payments usually beginning a month after you have paid a lump sum premium may be best for you.
You can determine the annuity payout in one of two ways: by asking for a quote on how much of a lump sum is required to generate the monthly income stream desired, or by asking how much of an income stream will be generated based on the lump sum you have available.
It costs nothing to shop around and see what type of income stream offers is available to you. Generally, obtaining quotes from 3-5 different companies will give you a good selection of guarantees to choose from to find the one that is best for you. A difference of only an additional $25 a month may not sound like much in a guaranteed income stream. But even small differences multiplied with time will make a huge difference over a lifetime.
This flexibility in funding and payout options, tax deferral and more make annuities a popular source of supplementary income for many retirees.
Income Tax Treatment
If you are trying to manage tax brackets, it is important to note only the interest portion of each payment is considered taxable income. The rest of each annuity payment will be considered a return of your principal. Income Taxes on the earnings of the annuity are spread over the payout period, which means you could pay fewer taxes in the early years, and more in the later years.
Deferred Fixed Annuities
With a deferred annuity, you allow your premiums and interest to accumulate and defer when the payout period begins to some future date that need not be selected at the time the contract is purchased. Just like the immediate annuities, your earnings are not taxed until they are withdrawn over the life of the payout period.
Are you under age 59 1/2?
It is important to consider that all annuities are insurance-based financial vehicles designed to provide income in retirement and may not be as liquid or tax penalty free as some other investment vehicles for those under age 59 1/2. There may be a 10% Federal Income Tax penalty on amounts withdrawn prior to age 59 1/2, that is in addition to regular income taxes.
Early Surrender charges
Surrender charges may also apply in the early years of the policy regardless of age if you withdraw over a certain percentage of your contract, usually 10% of the total principal payments. This amount could be available annually, or the amounts may be cumulative. Every contract is slightly different.
Depending on the contract, a new surrender schedule may occur on each subsequent deposit.
In the event of a nursing home confinement or death of the annuitant, depending on the contract language, early surrender penalties will often be waived.
There are also other minor fees and expenses to consider that are part of the contractual guaranteed. Adding riders you don't really need could cost you an extra .15+ per year.
In all contracts, the guarantees of a fixed annuity are contingent on the claims-paying ability of the issuing company, so choosing an insurer with good ratings is important.