Fixed Annuity

What Is a Fixed Annuity and How Does It Work?

A fixed annuity is a financial product sold through insurance companies that provides a safe place for cash to accumulate tax-deferred interest.

Fixed annuities are the most straightforward type of annuity. They also provide the most predictable and reliable income stream, usually with the lowest fees.

You pay for a steady stream of income, and, in exchange, the insurance company guarantees your principal plus a minimum interest rate. The contract you sign for the annuity will define how the money in the product grows. 

Depending on your contract, you can receive payments for a set number of years or the rest of your life.

Fixed annuities are a great product for conservative investors. The tax deferral over the deferment period is an added bonus, allowing for greater compounding. Another significant advantage is their allowance for rollover at the end of the term to another annuity, further deferring taxes.

Aamir M. Chalisa, MBA, LUTCF, MDRTGeneral Manager at Futurity First Insurance Group

Aamir M. Chalisa is the GM at Futurity First, leading Oak Brook’s top branch. With 30+ years’ expertise, chairs GAMA Global, driving diversity worldwide.

Accumulation and Payout of Fixed Annuities

A fixed deferred annuity consists of two distinct phases: accumulation and payout.

After you decide to buy a fixed annuity, the insurance company sets an agreement to pay you a minimum interest rate while your account grows. This is known as the accumulation phase.

During this phase, the current interest rate is applied. This annuity rate is guaranteed for that period. The earned interest in your account grows tax-deferred during the accumulation phase. 

The payout phase starts when you begin receiving guaranteed income from your annuity. 

There are numerous fixed annuity payout options to choose from. Payouts can be immediate — starting within a year of purchase — or deferred until a later date. Deferred annuities typically begin paying out in retirement.

You can guarantee income payments from a fixed annuity for life, commonly called a life annuity or single-life annuity. You can also choose a period certain annuity to receive payments for a set number of years. 

You may also elect to receive annuity income benefits as a lump sum.

How Are Fixed Annuity Rates Determined

Unlike variable annuities and fixed index annuities, fixed annuities are not linked to stock market performance. Instead, your money grows at a guaranteed interest rate determined by the annuity company.

Your fixed annuity contract will include a minimum guaranteed rate. The guarantee from the annuity company is that the interest on your fixed annuity will not dip below that rate. The company also guarantees the principal investment.

Some fixed annuities, such as multi-year guaranteed annuities (MYGAs), lock in the same rate for your entire contract. Others may adjust the interest rate after a certain time.

After the set period ends, another interest rate, called the renewal rate, applies. You can ask your agent or broker for a renewal rate table to give you an idea of what to expect. However, even if the interest rate adjusts over time, it cannot fall below the guaranteed minimum rate specified in your contract.

How Are Fixed Annuities Treated for Tax Purposes?

Fixed annuities are tax-deferred products, meaning you won’t owe any taxes on your annuity during the accumulation period. The tax-deferred feature allows your interest to grow unimpeded throughout the contract’s term. 

If you have a qualified fixed annuity — funded from a retirement account like a 401(k) or IRA — you’ll owe taxes on the total amount of your annuity withdrawals.

Fixed annuity owners who withdraw money from their contracts early may face a tax penalty. Withdrawals before the age of 59 1/2 typically incur a 10% penalty on the taxable portion of the annuity withdrawal.

Types of Fixed Annuities

Fixed annuities have two main types: traditional fixed and multi-year guaranteed. Immediate annuities, a separate type of annuity, also operate as fixed products.

Traditional Fixed

Traditional fixed annuities accumulate money based on a fixed interest rate set at the beginning of your contract.

The prevailing interest rates determine the initial rate for fixed-income investments. 

Insurance companies may increase the interest rate on your traditional fixed annuity contract after a specified period, such as two years. The new interest rate cannot fall below the minimum rate specified in your contract.

When shopping for a traditional fixed annuity, finding one that offers a competitive interest rate is essential.

For example, some insurers may offer a renewal rate slightly above the contractually guaranteed minimum. A relatively low interest rate may cause your annuity to struggle to keep up with inflation.

Make sure to carefully compare contract details before selecting a traditional fixed annuity.

Multi-Year Guaranteed Annuity (MYGA)

A multi-year guaranteed annuity, or MYGA, is another type of fixed annuity. MYGAs are similar to traditional fixed annuities, with the only real difference being the length of the guaranteed rate.

MYGAs guarantee the interest rate for the entire contract term. There’s no risk that the insurance company will change the rate as your money grows. If you purchase a five-year MYGA, the rate you receive at the start of your contract is locked in for five years.

In contrast, other fixed annuities only guarantee the initial rate for a certain portion of the contract.

Comparing Fixed Annuities

	Traditional Fixed	MYGA
Rate of Return	Fixed based on the contracted rate for a set period.	Locked in for the duration of the contract.
Risks	Rates can change — and potentially drop — after the specified period and may not keep up with inflation.	Rates may not keep up with inflation over time.
Tax-Deferred Growth	Yes	Yes
Beneficial For	Conservative investors and those planning for retirement.	Those looking for a safe and stable long-term income stream with little risk.

Who Should Buy a Fixed Annuity?

Annuity.org expert contributor Chip Stapleton finds that predictability is one of the most significant advantages of fixed annuities. It makes them particularly well-suited for risk-averse investors who are about to retire or are in their first few years of retirement.

“They’re very safe products that generate a small amount of return, but it’s guaranteed,” said Stapleton, a FINRA Series 7 and Series 66 license holder. “There’s no risk involved.”

Take a look at the case study below to get an idea of how a fixed annuity might benefit retirement planning.

Fixed annuities can be an attractive option for conservative investors planning for retirement like Kathy since they offer a predictable income stream.

The predictable returns of fixed annuities make them ideal for creating a retirement budget. You will know exactly how much money you are due without worrying about market performance impacting that figure.

That predictability can also make them valuable tools for creating bridges to other retirement income sources.

“I’m hoping to hold out until at least 67, possibly 70, before I take Social Security, so what I’ve basically done is gotten this fixed rate 10-year certain annuity essentially as a bridge between now and when I actually take Social Security,” Annuity.org customer Tracy Neill said.

A fixed annuity is also a strong choice for conservative investors who want to preserve their principal but want their money to grow faster than offered by a savings account or a CD.

Additionally, investors in high tax brackets will have even more incentive to choose the fixed annuity over other taxable options like a CD due to the annuity’s tax-deferred compounding. For someone with a 20% effective tax rate, a CD would need to yield a pre-tax 5% to equal the same return as the tax-deferred fixed annuity offering 4% each year. 

Stapleton said that a younger person might want a fixed annuity if they’re distrustful of the market and want a risk-free way to grow their money for retirement.

“But mostly, it’s going to be retirees and late retirees who are really stressing capital preservation,” said Stapleton.

Pros and Cons of Fixed Annuities

A big pro of fixed annuities is that they are considered the safest of all annuity types. They offer premium protection and the option to set up a stream of income that you can never outlive. 

Fixed annuities are also simple and predictable, making them attractive to conservative investors. 

“Annuities provide guaranteed returns, which leaves out the guessing and risk,” Steve Azoury, a Chartered Financial Consultant^® and owner of Azoury Financial told Annuity.org. “They also provide a guaranteed income which does not fluctuate due to stock market swings.”

Regardless of how the insurer’s investments perform, a fixed annuity will never earn less than its guaranteed interest rate. The guaranteed rate helps you easily predict how much income you’ll receive from your fixed annuity.

But despite the benefits, fixed annuities have drawbacks. 

One is that the product’s simplicity and predictability can come at the expense of having less growth potential than other, more complicated annuities. Fixed index annuities, for example, offer a safe and conservative way to still participate in real market gains.

Because fixed annuities grow at a guaranteed rate, they also cannot adjust for inflation, so their actual value may decline over time. The money withdrawn from any annuity is taxed as ordinary income, as it does not benefit from capital gains tax rates.

Finally, there may be better choices than an annuity for a customer who values liquidity. Money tied up in an annuity cannot be withdrawn without penalties or surrender charges. 

“Fixed annuities typically have bigger penalties for cashing out early than CDs and treasuries do,” Singer said.

Factors To Consider When Choosing a Fixed Index Annuity

If you are trying to determine whether a fixed annuity is the right choice for you, ask yourself several questions:

• How much money am I planning to place in an annuity?
• How soon will I need annuity payments to start?
• How do I plan to pay for this annuity?
• How likely am I to need the money in my annuity contract before it matures?

These questions can help you narrow down product choices and find the option that makes the most sense for you.

When comparing products, check the fine print of annuity contracts for things like fees, surrender charges and rider costs. Find out which riders the annuity provider offers and determine whether you would like to add any riders to your annuity.

Fixed annuities earn interest based on a guaranteed rate, so consider factors like how long that rate is guaranteed and how frequently the interest compounds.

An annuity is only as safe as the insurance company that sells it. While it is extremely unlikely an insurance company will go bankrupt, it’s important to select an insurer with an A rating from one of the major credit rating agencies, such as Fitch or AM Best.

Some annuity agents will not even work with companies that hold a rating below A.

FINRA advises anyone shopping for annuities to contact their state insurance commissioner to ensure that their broker is registered and authorized to sell annuities in the state.

The regulatory nonprofit also suggests you research your state’s guaranty association that will protect you if your insurer becomes insolvent.

As with any investment or insurance product, working with a financial advisor can be beneficial. Your financial advisor can provide fixed annuity recommendations based on your unique goals and risk tolerance.

Fixed Annuities in 2024

The rising interest rate environment contributed to record-breaking sales of fixed annuities in 2023, and that growth has continued through the first half of 2024. The insurance industry group LIMRA reported that deferred fixed annuity sales totaled $40 billion in the second quarter of 2024, up a staggering 32% from last year.

With so much uncertainty in the economy and its future direction, products offering a safe and stable way to grow nest eggs and create income have seen a continuing rise of popularity.

In a recent report, LIMRA highlighted that fixed annuities made up more than 40% of the total annuity market in 2024.

LIMRA also predicted that sales of the products will exceed $100 billion in 2024 and 2025. The last few years of steadily rising inflation continue to influence investors who want to make sure their retirement savings is protected from cost of living increases, and the reliable income and returns of fixed annuities offer a solution to this common concern

Frequently Asked Questions About Fixed Annuities