Annuity, Fixed

What it protects against

Annual income taxation. If annuitized, it can protect from running out of money, but it does not protect against inflation.

How it works

Fixed-annuity assets are part of the general fund of the issuing insurer. The general fund invests in conservative instruments. Annuities in their optional distribution - or payout - phase can provide greater income than comparably safe fixed-income products, because the lump sums provided by buyers to purchase their payout streams become part of a pool of money that is divided among survivors when other buyers die. The trade-off for buyers is that they give up access to their lump sums in order to buy their income streams. Income payments remain the same for the life of the annuitant.

Who needs it

Any investor (with fixed-income investments) willing to accept minimally more risks than government or government-insured securities in return for a potentially higher yield. Those planning to generate lifelong income. Those in need of retirement income right away may buy immediate fixed annuities.

Who may not need it

Those in lower income-tax brackets who do not need tax deferral. Those with retirement pensions. Elderly people who cannot wait for surrender charges to end.

When to buy it

Withdrawals prior to age 59 1/2 are subject to a federal income tax penalty. The benefits of tax-deferred compounding are greater over longer periods. For those annuitizing, the longer they wait, the greater the periodic payment will be. That is because periodic payments are based one one's life expectancy. Experts advise annuitants to diversify interest-rate risk by making several purchases over several years instead of making a single purchase.

How you pay for it

Single of multiple premiums.

Terms to Know

Annuitization (View Definition Hide Definition)

Process by which you convert part or all of the money in a qualified retirement plan or non-qualified annuity contract into a stream of regular income payments, either for your lifetime or the lifetimes of you and your joint annuitant. Once you choose to annuitize, the payment schedule and the amount is generally fixed and can’t be altered.

Annuitization Options (View Definition Hide Definition)

Choices in the way to annuitize. For example, life with a 10-year period certain means payouts will last a lifetime, but should the annuitant die during the first 10 years, the payments will continue to beneficiaries through the 10th year. Selection of such an option reduces the amount of the periodic payment.

General Account (View Definition Hide Definition)

All premiums are paid into an insurer's general account. Thus, buyers are subject to credit-risk exposure to the insurance company, which is low but not zero.

Laddering (View Definition Hide Definition)

Purchasing bond investments that mature at different time intervals.

Surrender Period (View Definition Hide Definition)

A set amount of time during which you have to keep the majority of your money in an annuity contract. Most surrender periods last from five to 10 years. Most contracts will allow you to take out at least 10% a year of the accumulated value of the account, even during the surrender period. If you take out more than that 10%, you will have to pay a surrender charge on the amount that you have withdrawn above that 10%.