Pros and Cons of Fixed Annuities

Fixed income annuities can be funded either with a single lump-sum payment or through a series of contributions made over time. In return, they provide retirees with a guaranteed stream of income that doesn’t fluctuate with the market. This steady payout can complement Social Security or pensions, offering predictable cash flow for life or a set period. However, considerations like limited access to funds and the potential erosion of purchasing power from inflation mean they may not suit every financial plan.

A financial advisor can help you find additional sources of income for your retirement portfolio.

What Are Fixed Annuities?

A fixed annuity is a contract with an insurance company that exchanges your premium, paid either as a lump sum or through multiple contributions, for a guaranteed interest rate and predictable income.

During the accumulation phase, your money grows tax-deferred at the fixed rate outlined in the contract. This growth is unaffected by stock market performance, making returns steady but capped.

When you reach the payout phase, the insurer begins distributing income according to your chosen schedule. Payments can last for a set period, such as 10 or 20 years, or continue for as long as you live. Some contracts even extend benefits to a surviving spouse.

The guaranteed interest rate typically applies for an initial period, often three to 10 years, after which the insurer may adjust the rate. Contracts disclose both the initial guarantee and the minimum rate you’ll receive once the period ends, so you know the lowest return possible. This structure provides certainty up front while still allowing insurers flexibility to adapt to economic conditions.

Reasons Why You May Want a Fixed Annuity

Fixed annuities can play different roles in a retirement plan beyond simply providing income. Their structure combines predictability with features that appeal to those seeking stability, tax advantages, and even legacy planning.

Steady Income Stream

A fixed annuity offers predictable payments that can be structured to last for a set number of years or for life. This income stream can supplement other retirement resources and help cover ongoing expenses. Payment size and frequency vary by contract, so terms must be reviewed carefully.

Guaranteed Interest Rate

Unlike market-based investments, a fixed annuity provides a contractually guaranteed rate of return during the accumulation phase. While the rate may be modest, it removes uncertainty and allows you to know exactly how much your principal will grow over the guaranteed period.

Tax-Deferred Growth

Contributions inside a fixed annuity grow without immediate taxation. Interest compounds until withdrawals or payments begin, which can help grow your balance more efficiently than a taxable account. This structure can be especially appealing for those seeking to delay taxes until retirement, when income may be lower.

Options for Beneficiaries

Many fixed annuities come with death benefit provisions that allow remaining funds to transfer to heirs. Some contracts automatically include this feature, while others offer enhanced benefits through optional riders for an added cost. This makes fixed annuities not only an income tool but also a potential estate planning resource.

Protection from Market Volatility

Because a fixed annuity’s returns are not tied to the performance of stocks or bonds, it can offer stability during periods of market turbulence. This makes it attractive for those who prefer consistent growth without exposure to sharp declines.

Customization Through Riders

Many insurers allow policyholders to add riders that expand the annuity’s benefits. Examples include cost-of-living adjustments to help offset inflation or long-term care riders that provide support if health needs arise. These features often come with an extra charge but allow the contract to be tailored to specific goals.

No Contribution Limits Outside Retirement Accounts

Unlike IRAs or 401(k)s, which impose annual caps on how much you can contribute, nonqualified fixed annuities generally do not have such restrictions. This makes them an option for individuals who want to continue putting money into tax-deferred vehicles after maxing out traditional retirement accounts.

Reasons Why You May Not Want a Fixed Annuity

Man calculates his future income stream to determine if he needs an annuity.

However, fixed income annuities aren’t a panacea. While fixed annuities provide stability and predictable income, they also come with limitations that may not fit every financial situation. These drawbacks relate to liquidity, inflation, costs and contract restrictions.

Limited Liquidity

Fixed annuities usually restrict how much you can withdraw each year, often capping it at a small percentage of the account’s value. Because of these limits, they are not well-suited for covering sudden, large expenses, making it necessary to maintain other accessible assets for emergencies.

Inflation Risk

Since payments are tied to a fixed rate of return, the income from a fixed annuity does not automatically adjust with inflation. If living costs rise significantly, the purchasing power of those payments can decline over time.

Surrender Charges

Most annuities impose a surrender period, which can last several years. Withdrawing more than the allowed amount during this time often triggers surrender charges that reduce your payout.

Potentially Higher Fees

Compared with other retirement income tools, fixed annuities may involve higher administrative and rider fees. These costs can vary widely by insurer, so comparing contracts is an essential step before committing.

Limited Growth Potential

Because returns are fixed, annuities generally do not offer the opportunity for higher gains during strong markets. This trade-off of security for stability means they may underperform relative to other long-term investments.

Does a Fixed Annuity Belong in Your Portfolio?

Determining whether a fixed annuity belongs in your retirement plan often comes down to how you balance predictability with growth potential. These contracts can be appealing for those who value certainty in their income stream and prefer to shift part of their portfolio away from market-driven assets. For conservative investors, a fixed annuity can function like a personal pension, smoothing out income in later years.

Another factor is timing. Fixed annuities may suit individuals approaching retirement who want to lock in guaranteed payments before leaving the workforce. Younger savers, on the other hand, may find the limited growth potential less appealing, since their longer time horizon allows them to benefit from the higher returns of equities and other market-linked investments.

Fixed annuities can also interact differently with tax strategies depending on the source of funds. Using after-tax money in a nonqualified annuity can extend tax-deferred growth beyond traditional retirement account limits, while purchasing one inside a qualified plan like an IRA or 401(k) may reduce its relative advantages.

Bottom Line

Young woman looks at various annuities on the internet.

Fixed annuities occupy a middle ground between security and flexibility, offering steady income and tax advantages while also imposing limits that may not suit every retiree. They can provide a sense of predictability in an otherwise uncertain financial landscape, but their trade-offs such as surrender charges, fees, and inflation risk make them best considered alongside other retirement tools. By weighing both their benefits and constraints, retirees can decide whether a fixed annuity complements their broader mix of income sources and long-term goals.

Retirement Savings for Beginners

A financial advisor can help you create a financial plan for your retirement goals. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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