Common Features of a Fixed Annuity

Guaranteed Rates of Return
Return of Principal Guarantee
Minimum Guaranteed Rate
Tax Deferral
Lifetime Income Option - Annuitization
Withdrawal Options
Annual Resets

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Guaranteed Rates of Return

Fixed Annuity Rates Guaranteed

The reason most people like fixed annuities are for the guaranteed rates they offer.  Most fixed annuities offer an annual interest rate that is fixed and guaranteed, sometimes for the life of the contract and other times the rate will reset annually but never going below a certain minimum rate. 

Fixed annuities are often times a very good alternative to Certificates of Deposit (CD’s) offered by banks.  They are both very similar in nature, with specific terms and fixed interest rates.  Because fixed annuities are so easy to understand it is no wonder they make up 75% of the annuity marketplace. 

            Example:  Tom purchases a 5 year fixed annuity for $50,000 with a guaranteed rate of return of 6%.  Not only does Tom have peace of mind that his money is secure he also knows exactly how much money he will have at the end of the term.  To calculate how much money this fixed annuity would generate Tom would use a simple calculation:  $50,000 x (1+0.06)^5 = $66,911.28.  This fixed annuity is especially interesting to Tom because he knows that at the end of the 5 year term he will have earned $16,911.28 in interest, worry free.

Return of Principal

One feature that some fixed annuities offer is called a Return of Principal option.  What this means is that even if you surrender your fixed annuity before the contract expires you are guaranteed back 100% of your principal no matter what. This feature can sometimes be hard to understand because it is almost counterintuitive.  Let’s look at the following example to see how this return of principal guarantee works.

            Example:  Tom purchases a fixed annuity with a return of principal rider for $100,000.  This fixed annuity has a contract length of 5 years and is guaranteed to earn 5% interest.  If the annuity is surrendered prior to the 5th year it is assessed with a surrender schedule as follows:  9%, 9%, 8%, 7%, 6%.  Do to some unforeseen circumstances Tom has to surrender this annuity in year 2 and is subsequently hit with a 9% surrender penalty.  In year one Tom earned 5% interest so in year two his fixed annuity is worth $105,000.  The surrender penalty that Tom is faced with is $9,450 ($105,000 x 0.09).  Because this contract has a return of principal feature the $9,450 penalty will only be applied to his interest and Tom will receive his initial investment back of $100,000; i.e. Return of Principal. 

Minimum Guaranteed Rates

Juts about all Fixed Annuities have what is called a minimum guaranteed rate.  What that means is that no matter what happens to interest rates in the economy the rate that they will receive is guaranteed to be no less than the specified rate upon purchase.  Most fixed annuities offer an annual interest rate that is well above the minimum guaranteed rate for the initial contract.  For example, a fixed annuity may offer a 5 year rate for 5% with a minimum guaranteed rate of 3%.  What that means, is that after the 5 year term is up the insurance company will then choose a new interest rate that has to be higher than 3%.  This would benefit an investor if the going interest rates was below 3% at time of renewal because they have a contract where they are to receive at minimum 3% return.

Tax Deferral

A very popular feature that fixed annuities enjoy is tax deferral.  This is also one of the biggest reasons that investors choose fixed annuities over Certificates of Deposits (CD’s).  Since an annuity is offered by an insurance company, by investing in a fixed annuity you are essentially buying an insurance contract with a specified maturity and a specified rate of return.  Since your money is with an insurance company you don’t have to pay taxes on the interest that you earn so long as you leave it in the annuity.  For example if you purchase a 5 year fixed annuity that earns you $20,000 in interest over the life of the contract, as long as you don’t withdrawal the $20,000 you can avoid paying taxes on that interest.  Not only can you defer the taxes on an annuity you can even transfer those gains (interest) from one fixed annuity to another fixed annuity without paying any penalties or taxes.  The only time you pay taxes on the interest that you earn is when you withdrawal it.
 
Life Time Income Option – Annuitization

One of the greatest options for retirees is the option of annuitization.  Fixed Annuities are generally geared toward the accumulation of money through fixed interest rates.  Once a person has a contract with an insurance company (a fixed annuity) the insurance company will issue projections for how much monthly income their fixed annuity will provide given its current value.  Once a person decides to annuitize their fixed annuity they will receive lifetime income regardless of how long they live.  Essentially what the investor is doing is transferring the risk that they might outlive their money to the insurance company. 

            Example:  Tom owns a fixed annuity that is currently worth $225,000.  Tom is 65 years old and is looking for a way to provide him with guaranteed monthly income.  The insurance company that issued Tom’s fixed annuity has told him that if he wants lifetime income he can “Annuitize” his contract and give the insurance company the $225,000 in exchange for monthly income of $1,500 per month for the rest of his life.  Tom can rest easy because he knows that no matter how long he lives he will continue to receive his $1,500 pre month.

Withdrawal Options

Since fixed annuities are typically offered for periods of 5-10 years they offer many different options for investors to get their money out free of penalty.  One common feature that most fixed annuities offer is a 10% free withdrawal option that allows investors to withdrawal 10% of their annuity’s value after the first year.  This is called the 10% free withdrawal option.

Another common withdrawal option is known as a nursing home provision.  A Fixed Annuity with this option allows the investor should they ever be confined to a nursing home or long term care facility to withdrawal 100% of their money out free of any penalties what so ever.

In most cases if the owner of a fixed annuity is to die, the annuity would pay 100% of the annuity value to the beneficiary free of any penalty. 

For the reasons listed above fixed annuities are very attractive for investors looking to limit stock market volatility and provide stable and steady returns with flexibility to withdrawal money should the need arise.

Annual Resets

Fixed annuities that are not offered with a guaranteed rate of return for the entire contract typically reset the interest rate each policy anniversary:  this is known as an annual reset.

            Example:  Tom purchases a 5 year fixed annuity with a 7% interest rate and a 3% minimum guarantee.  Tom would receive 7% in year one and on his first policy anniversary the insurance company will announce a new interest rate for the coming year not to go below the minimum of 3%, this would continue for the length of his contract.  This is called an annual reset.