Is a Fixed Annuity Right for You and Your Retirement?

Learn how fixed annuities operate as Fisher Investments breaks down their stages, costs and challenges.

A fixed annuity is the most basic of annuities investors are likely to be offered for their retirement. This type of longevity insurance provides the owner with a guaranteed income stream for their retirement in exchange for premiums. Before the owner begins taking payments, the deposited premiums earn a flat (i.e., “fixed”) rate of return. Functionally, these annuities serve to transfer the risk of outliving assets from the annuity owner to the insurer. But as with all annuities, the specific features and riders associated with any particular fixed annuity can vary widely, as can their consequent suitability for a particular retirement plan.

Because of the guaranteed return rate, sellers of these contracts will likely tell you they come without the risks of the investment market—but, in reality, fixed annuities are never risk free. Rather, they simply let you trade one risk for another. Investors looking to provide for their retirement lifestyle must look critically to figure out if this type of product is right for them. Consequently, it’s vital for investors to understand the differences among annuities that can greatly affect how a fixed annuity will work in their portfolio.

Immediate vs. Deferred Annuities

As we’ve mentioned, even under the banner of “fixed annuities,” there is a wide range of varieties. One of the main distinguishing features among them is the length of their accumulation phase. With an immediate fixed annuity, the premium is paid upfront as a single, lump-sum premium. There is little-to-no accumulation period, and the income stream begins no later than one year after purchase.

More commonly, however, annuitization occurs at a later date. This kind of product is known as a deferred fixed annuity. Under the terms of a deferred annuity contract, the principal earns its rate of interest as set by the insurance company. Once the contract becomes annuitized, the income payment is set and will generally not change for the duration of the contract (without a potentially costly “rider”).

Riders: Why the Attractions of a Fixed Annuity Are Often Just More Drawbacks

Another commonly marketed feature of some annuities are the various “guarantees,” like “guaranteed income for life,” “guaranteed growth,” “death benefits” or “long-term care insurance.” While these features make a fixed annuity seem initially attractive, some provisions may actually be extras commonly known as “riders.” These additional benefits often come paired with additional fees or expenses that can quickly eat into your return. Though riders are less common with fixed annuities than indexed or variable varieties, these fees can have a larger impact on their rates of return, which tend to be lower than those of other types (especially when inflation is factored in, as we will discuss later).

How Risky Is Your Fixed Annuity, Anyway?

Fear of risk is one of the most common reasons investors choose annuities, but the many types of risk they carry are often overlooked. Since a fixed annuity provides a consistent rate of return and is not as easily transferable as typical securities like stocks or bonds, it’s frequently seen as having a low risk of volatility. But it’s important to remember: Our instincts to avoid risk often act against us when it comes to investing. Safe returns from a fixed annuity will look more attractive in markets where interest rates and returns are low, but these periods may also be when annuities are offering their lowest rates due to high demand.

Conversely, buying an annuity with a lower fixed return may seem unwise, when stock indexes are showing double-digit returns and interest rates are rising. But this may also be the one of the few times you’ll find an attractive interest rate on a fixed annuity, as insurers have to offer more generous terms to attract investors. Though this situation also begs the question, is the annuity’s safety worth giving up the opportunity for such growth?

Purchasing a fixed annuity too early may also create significant opportunity costs. These products often have annual interest rates of about 3% or less.1 Given that annual inflation alone is roughly 3%,2 this low rate of return is not likely to achieve the growth needed to meet most people’s retirement goals. This is particularly true for folks living in an era of increased life expectancy. Plus, a fixed annuity is likely to come with rigid terms and conditions that could subject the investment to major penalties—such as stiff exit fees, which make it financially painful for annuitants to reinvest their principal or to seek a better deal elsewhere.

So, what are some important questions to consider before signing up for a fixed annuity? Here at Fisher Investments, we think you’ll be well served by asking the following questions:

  • How does the annuity affect your ability to access your retirement funds? A fixed annuity, like any annuity, has two phases: growth (accumulation) and pay-out (annuitization). In the first phase, there are usually limits on how much can be withdrawn from the account each year (10% is common3). Beyond this, there can be major penalties (7% is common4) for withdrawals. There may also be tax penalties for annuities purchased with tax-deferred dollars if funds are withdrawn before age 59½ (though some exceptions are made for “Public Safety Officers” who can make withdrawals at 50 if the annuity is purchased through a qualified retirement plan). In these cases, Uncle Sam will take not only his regular taxes, but an extra 10% penalty. In the pay-out phase, it’s generally impossible to get any principal back on demand, as the funds have become the property of the insurer. It’s important to thoroughly understand how your unique annuity contract is structured to determine if this provision creates additional risk for your retirement.

  • How likely is there to be a shortfall in your retirement savings given your projected time horizon and cost of living? All annuities are, at their core, a form of longevity insurance. Their primary value comes from their ability to protect their owners from outliving their assets. Consequently, if you believe you’re at little risk of outliving your assets, a fixed annuity is unlikely to provide any benefit. You may want to consult a retirement planner who can analyze your portfolio relative to your goals and advise you on whether this trade-off is sensible in your situation.

  • How will inflation impact your annuity’s payments? Most annuities are structured to make consistent periodic payments. Over time, inflation (and increases in cost-of-living expenses) can erode the purchasing power of these payments. Again with average annual inflation at around 3%5, it’s important to consider how your payments’ purchasing power will be affected. When factoring in costs like increasing medical expenses, the actual inflation experienced by retirees for their expenses can be significantly greater than this average. While some options do exist that provide increasing payments over time, they generally come at the trade-off of lower payments up front. Depending on your time horizon, the slower return up front could significantly reduce the likelihood of seeing the full promised benefit from your annuity.

Still have more questions about fixed annuities, or any other type of annuity, for that matter? Here at Fisher Investments, we have extensive experience helping those in, nearing or planning their retirement to develop investing strategies that are properly aligned with their goals. Having seen many clients locked into annuity contracts that simply didn’t meet their needs, we’ve developed our Annuity Evaluation service6 to help qualified investors understand these products via an honest and thorough analysis. Our Annuity Counselors can break down these complex contracts (or even discuss them directly with their providers) to provide clear feedback on what is actually being offered.

Contact us today to request an appointment with an Annuity Counselor to discuss your fixed annuity, or to discover more about how we can help with developing a robust investment portfolio to support your retirement.


1Source: Securities and Exchange Commission, Variable Annuities: What You Should Know, https://www.sec.gov/reportspubs/investor-publications/investorpubsvaranntyhtm.html;

2Source: FactSet Global Financial Data as of 07/12/2017. 2.9% average based on US BLS Consumer Price Index from 1926-2016

3Source: CNN Ultimate Guide to Retirement: Annuities, “What if I decide to withdraw the money?” http://money.cnn.com/retirement/guide/annuities_basics.moneymag/index9.htm.

4IBID.

5Source: FactSet Global Financial Data as of 07/12/2017. 2.9% average based on US BLS Consumer Price Index from 1926-2016

6Terms and conditions apply