Fixed annuities are popular retirement savings vehicles. Annuities can be used for additional tax-advantaged savings when an individual has reached the limits for his 401k and IRA savings plans. Annuities are also a retirement savings product where a single, large sum of money can be invested in a safe, tax-advantaged product to be used for retirement income when that time comes around.
Annuities are Insurance Products
Fixed annuities are products from life insurance companies. They are sold by representatives with life insurance licenses. All value protection of annuity assets is from the strength and reserves of the individual life insurance companies. Fixed annuities provide little insurance protection in the accumulation phase. Fixed annuities earn interest which compounds to an annuity's cash value. If the annuity owner dies, the cash value will be paid to the beneficiaries. When the annuity payout starts in retirement, the insurance part becomes more obvious. The annuity owner can select a life income option that will guarantee that an income will be paid as long as the annuity owner lives. The life income possibility is a major benefit of annuities, as it means having a guaranteed income that cannot be outlived.
Income Tax Deferral
Fixed annuities earn interest that is deferred from income taxes until payments are received from the annuity. The tax deferral works similar to an IRA, where if withdrawals are made from an annuity before age 59 1/2, there are extra tax penalties. Fixed annuities are the only investment product where an individual can deposit a large sum of money and have it earn tax-deferred interest and there is not a risk of market value losses. The payments from an annuity, when it starts to pay an income stream for retirement, is also tax advantaged. Each payment is considered by the IRS to be a partial return of principal and only part of each payment is taxable income.
Fixed, Competitive Interest Rates
Fixed annuities pay a competitive interest rate when compared with other income products like CDs, bonds and bond mutual funds. Annuities are available with the interest rate guaranteed from one to several years. After the rate guarantee period ends, the insurance company will pay interest on an annuity based on the company's own investment results. Annuities have surrender fees for the first several years. A good annuity will have the surrender fee period match the interest rate guarantee period. If the rate paid after the guarantee period is not competitive, the annuity can be exchanged for another fixed annuity from a different insurance company.
- The Investment FAQ: Insurance: Annuities
- Fixed Annuity | How Fixed Annuities Work
- Investor.gov. "Annuities." Accessed Sept. 1, 2020.
- Internal Revenue Service. "Publication 575 (2019), Pension and Annuity Income." Accessed Sept. 1, 2020.
- Internal Revenue Service. "Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other than IRAs." Accessed Sept. 1, 2020.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.