Here is a summary of some of the potential pros & cons of fixed annuities (not a comprehensive list):
PROS
Simple products:
Unlike many financial products, fixed annuities are some of the simpler ones. Fixed annuities are insurance products offered by insurance companies. A few initial key questions you need to ask when buying a fixed annuity are what is your goal for your money (e.g., growth only or income?), how long your money is locked up for (and what options you have for liquidity) and what your growth will be during that time.
Guaranteed minimum rates:
You’ll know the fixed annuity’s interest rate right up front before you purchase the annuity from an insurer, and the insurer guarantees your money to grow at this rate during the initial guarantee period. After the guarantee period, the rate could change.
Guaranteed principal:
The principal portion of fixed your fixed annuity (as well as any other promises like the guaranteed minimum rate) is guaranteed by an insurance company that sold you the fixed annuity. Unlike bank CDs, which are insured up to the legal limit of $250,000 by the FDIC, fixed annuities are not federally insured. Therefore, assessing the financial strength of the insurer issuing the fixed annuity is important; Insurance companies are rated by a number of large rating agencies for their financial strength and creditworthiness, including A.M. Best, S&P and Moody’s.
Predictable growth:
The growth of fixed annuities is stable and predictable, as they are promised to you per the fixed annuity contract. These contractual returns are not volatile, as they are not tied to the equity markets or any other fluctuating market (i.e., commodities, etc.). The way the insurance company is able to promise and offer fixed interest credits is as follows: you give the insurance company money to buy the fixed annuity, the insurance company then invests this money held on your behalf in primarily high-quality corporate and government bonds, generating a pool of return, and finally, a portion of this investment return that it generated is given to you to provide your guaranteed fixed annuity interest credits.
Tax-deferral:
Interest earned and accumulated each year for a fixed annuity is NOT taxed until you withdraw the money. Traditional IRAs, Roth IRAs and 401(k) plans all grow your money similarly in a tax-deferred manner. This means that your fixed annuity grows and compounds its interest earnings in a tax-deferred manner, only taxed when you take money from your fixed annuity. This can make a big difference in how much faster your money can grow vs savings that are taxed annually.
Guaranteed income:
Fixed annuities offer the opportunity to turn the accumulated annuity value into a guaranteed income stream. This process is called “annuitization” and allows you to choose an income stream for a period of time, for your lifetime or a combination of the two. Once you annuitize the contract, the decision is irrevocable and you cannot cancel the contract for a lump sum. This guaranteed income can help you cover essential expenses in retirement with greater confidence.
CONS
Lack of liquidity:
Fixed annuities typically allow for a portion of your account balance to be withdrawn once each year without a surrender penalty at your discretion, although a 10% penalty may apply if you are under age 59½. However, once you reach age 59½ , you can typically withdraw 10% of the cash value of your annuity without a federal tax penalty. All withdrawals will be subject to ordinary income taxes. Thus, fixed annuities may not be appropriate for those that need all of that money ready for financial emergencies, accessible at all times.
Surrender charges:
Fixed annuities have a surrender period that typically ranges between 5-10 years. Often this is the same time period as the interest rate guarantee period (i.e., the period of time for which you will get a guaranteed fixed interest rate). During any year within this period, if you withdraw more than what’s allowed without a surrender penalty (typically 10% of the cash value), you will be charged a fee called a surrender charge. This surrender charge is only applied to the excess amount withdrawn above the allowable, free withdrawable amount. Most fixed annuities have a declining surrender charge schedule that may start as high as 10% in the first year of the surrender/guarantee period and typically declines 1% every year thereafter. Keep in mind that ordinary income taxes will also apply to any withdrawals.
IRS penalties for withdrawals when under 59½ years of age:
If you’re under 59 ½ years of age and withdraw from your fixed annuity, the IRS puts a 10% penalty on such withdrawals. Thus, fixed annuities may be more suited for retirees or those close to retirement age.
Annuities are long-term products designed for retirement income. Annuity guarantees are backed by the financial strength and claims-paying ability of the issuing company. Product and feature availability may vary by state.
Note: This summary is a generalization. This summary does not cover all products or companies that offer them. Please review each product's specific terms and features, as they may differ from the details in this summary. Updated as of January 15, 2023.