How Safe Is a Fixed Annuity?

by Contributing Writer ; Updated July 27, 2017

Fixed annuities are considered a "safe" investment. Issued by insurance companies, they are somewhat similar to CDs. They offer a fixed rate of return credited annually on a tax-deferred basis, allowing the investor a chance to earn a decent rate of return without risking principal.

Definition

Considering the broad spectrum of investments available in today's financial products marketplace, a fixed annuity definitely falls in the "safe category." But how safe are fixed annuities? In short, the safety of a fixed annuity depends largely on the financial institution backing your investment. The insurance company that issued the annuity must be able to credit the interest rate it promised, which is a contractual obligation. If for some reason the insurance company fails to deliver on its promise, each state's guaranty association must kick in and honor the promise the financial institution made to its investors. This rarely happens.

Function

A fixed annuity allows a lump sum of money (usually $10,000 or more) to earn a guaranteed rate of return each year. A fixed annuity is a tax-deferred vehicle, therefore not requiring the interest earned to be subject to ordinary income tax each year. The money inside the fixed annuity also is not driven by the stock market or any other volatile index, therefore making the investment extremely safe. Each year, the financial institution that issues the annuity will credit an interest rate to the principal balance like a bank will for a CD.

Multi-Year Fixed Annuities

Most fixed annuities come with multi-year guarantees, meaning that for a certain number of years from contract issue, the insurance company guarantees an interest rate no matter how the insurance company performs as a whole or how the economic climate changes. This can be extremely advantageous for an investor who is looking to simply earn a modest rate of return without risking any principal. For example, an insurance company may offer a 5.00 percent guaranteed rate for the first three years of the fixed annuity. This means the investor will earn a 5.00 percent credit each year for the first three years. No more. No less. Once the three years are up, the insurance company then can declare a new rate based on the guidelines of the contract (usually not less than 1 percent or 1.5 percent).

Surrender Charges

Fixed annuities usually come with a declining surrender charge schedule. This means that if during the surrender period of the fixed annuity (this usually runs three to 10 years), if the investor withdraws from the fixed annuity, a surrender charge will be assessed. This surrender charge usually starts high (in the 9 to 10 percent range) and then declines over the three to 10 years until it is zero. Insurance companies usually allow the interest earned each year to be withdrawn free of any surrender charges, or 10 percent of the entire annuity value. Read the contract specifics carefully, as these rules vary greatly depending on the insurance company and its products.

Security

For investors looking for conservation of principal, tax-deferred growth and a modest rate of return, fixed annuities may be a good choice. The ability to earn a guaranteed rate of return each year without having to worry about how the stock market performs can be a safe way to invest.