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Life Health > Annuities > Fixed Annuities

Why Fixed Annuities?

By Paul Garofoli

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What You Need to Know

  • Variable annuities offer owners a chance to get higher returns.
  • Fixed annuities tend to have lower levels of risk and lower fees.
  • For many clients, a fixed annuity can be a good alternative to a bond fund.

Clients who have attempted their own research on individual annuities may have encountered conflicting and sometimes negative information.

With so much confusion surrounding annuities and the contrasts between differing types, it can be difficult to help clients understand whether they are the right addition to their retirement portfolio. However, with a little context and explanation, individual annuities can be demystified, and clients can make more informed decisions.

Definitions

As an advisor, you most likely know that an annuity is an insurance contract that is created when an individual makes a payment (or a series of payments) called premium(s), which will generally grow at a set rate and in a tax-deferred status. In return, the insurer offers crediting options for accumulation or periodic payments back to the individual.

Clients, however, may not have this knowledge — by providing a basic definition like this, you can help frame the conversation for those trying to understand how annuities work at the most basic level. From there, you can expand on the different types of individual annuities.

Two Main Types of Individual Annuities

Once your clients have a general understanding of what an individual annuity is, it’s important to distinguish between the two main types, fixed and variable, to better help them evaluate which option might be right for them.

A fixed annuity guarantees to pay a specified interest rate that is based on the current interest rate environment, and many guarantee no loss of the principal outlay. The initial rate is guaranteed for one or more years, and subsequent renewal rates are guaranteed to stay above a specified minimum rate. Because it provides several guarantees, a fixed annuity is viewed as a conservative financial product.

A variable annuity offers earnings and income payments that fluctuate with the performance of specific investment funds. While variable annuities have the potential to provide higher returns, they differ from fixed products because the policyowner bears the investment risk and potential loss of principal. As these products are more complex and have more risk associated with them, the advisor who sells this annuity must also be licensed to sell securities.

Fixed vs. Variable: The Key Differences

Fixed annuities have many benefits that make them attractive additions to any retirement portfolio. As mentioned previously, many fixed annuities provide protection of the principal. This means that regardless of how the financial market performs, a fixed annuity owner will never lose their premium payments so long as the annuity carrier remains solvent. This benefit makes fixed annuities a safe choice for those who aren’t comfortable with or can’t afford to take as many risks with their money. This is particularly appealing to those approaching retirement.

With a guaranteed interest rate, fixed annuities can also provide a protected and predictable stream of income to owners. This also means potentially higher returns than other safe money alternatives like certificates of deposit (CDs), money market funds and even some bond funds. Due to these guarantees, fixed annuities can also be a great option for people who only have a limited amount of money saved for retirement and want to benefit from moderate principal growth and preserve the option to receive regular income. In addition, because of the relatively straightforward nature of the contract, fixed annuities have few to no fees, providing a potentially better value.

Variable annuities, in contrast, are inherently riskier. With a fixed annuity, the insurance company is taking on the investment liability, but with a variable annuity, that liability lies with the policyowner. There is also no automatic guarantee that the principal payment will be fully protected since the performance of a variable annuity is directly tied to the performance of investment funds, making it more volatile.

Variable annuities also come with more fees, which may not be as much of an issue when the market is performing well, but when it isn’t, having to pay a series of fees while also losing value may be too costly for some policyowners. Additional guarantees may be added to a variable annuity, but those, too, typically come with additional fees.

Because variable annuities are investments, policyowners typically review more documentation, need more specialized advisors or investment advice, and require a higher degree of investment understanding.

Who Needs What?

Individuals who would benefit the most from fixed annuities are:

  • In retirement and cannot afford to suffer a loss to their retirement funds, or are five to 10 years from retirement and won’t have the time to recover from a stock market loss.
  • Seeking an alternative to CDs, money markets and bond funds with potentially better and more consistent yields.
  • Interested in a constant-stream-of-income option that would resemble pension payments.

Those who would benefit the most from variable annuities are investors who can handle the risk and have more time to bounce back from a down market.

Guaranteed Income

Fixed annuities and variable annuities are two distinct products that have sometimes been lumped together, causing confusion and hesitation.

Separately, either could serve as a beneficial component to a diversified portfolio, depending on the needs of the annuity purchaser.

For clients who need more guaranteed income now or in the future, however, fixed annuities are a safe option, provide interest rates superior to most CDs and money market accounts, defer taxes and provide a steady income stream.

Paul GarofoliPaul Garofoli, FLMI, is a regional sales director of individual annuities at The Standard.

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