Fixed annuities are available from countless insurance companies, and each product offers a plethora of features and advantages. Depending on your situation, a fixed annuity might seem the ideal place for your retirement money. Before you purchase one, familiarize yourself with the potential downsides and make sure it's suitable for your goals, time horizon and risk tolerance.
Fixed Interest Earnings
Fixed annuities typically begin with a declared interest rate and duration for which that rate would apply to money in the account. Insurance companies might offer multiple annuity products, each with different rates and durations. The initial interest rate is often based on current economic conditions and the insurance company's outlook on future market performance. By investing in a fixed annuity with a lengthy initial interest rate period, you could miss out on rate increases resulting from positive economic performance.
At the end of a fixed annuity's initial interest rate guarantee period, most contracts allow the insurance company to declare a different rate annually. If market performance decreased during your annuity's initial period, or if the insurance company believes further declines are likely to follow, your new rate could be substantially lower. Although most fixed annuity contracts contain provisions specifying a minimum annual interest rate, nothing prevents the insurance company from simply maintaining the bare minimum percentage credited to your account.
Fixed annuities are a safe place to grow your retirement savings, but they can be extremely cumbersome if you later want to invest elsewhere. Nearly every fixed annuity contract contains provisions allowing the insurance company to keep a percentage of your account value if you close your account too soon. These "surrender charges" often range from 7 to 10 percent, sometimes higher. The surrender charge usually decreases by 1 percentage point each year until it eventually disappears.
Because annuities are retirement products, their owners enjoy certain income tax benefits. Most notably, those benefits include tax-deferred growth and, in some cases, tax deductions for contributions. In exchange for these tax advantages, the IRS restricts access to money in these annuities until you are at least 59 1/2 years old. If you withdraw money from your annuity before that, you are likely to be 10 charged percent early-withdrawal penalty, in addition to ordinary income taxes on your distribution. The IRS early-withdrawal penalty is separate from any surrender charges that the insurance company imposes.
Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.