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A fixed annuity is a type of retirement product purchased through an insurance company. The insurer determines the interest rate by which your account grows every contract year. The rate is fixed, meaning it doesn't fluctuate with market conditions. During what is known as the accumulation phase, you make a lump-sum payment or a series of regular contributions to the account, and the money grows tax-deferred. At the end of the term, you can annuitize the contract — convert it into a guaranteed stream of income that lasts for a specified length of time or the rest of your life.
Annuities are a popular option among retirement investors looking to add some stability to their portfolio. Let's look at five of the top benefits of fixed annuities for retirement so that you have a better sense of how they can help you realize your financial goals.
The insurance company specifies the return rate upfront when you purchase a fixed-rate annuity. Not only that, but they guarantee that return rate for the entire contract term. Then, when you convert the contract into distributions in retirement, the income is guaranteed for the rest of your life or for a specified period thereof. As a result, there is no question that you will receive a steady supply of income with a fixed annuity.
Fixed annuities are low-risk because the fixed rate protects your principal, the amount of money you initially contribute to the account. The interest rate is always above 0%, so the account increases in value every year in the life of the contract. For comparison's sake, think of a variable annuity, whose interest rate depends on market performance and, therefore, presents some risk of zero gain in some contract years.
The fixed rate offers another advantage in that it allows you to more easily determine the size to which your annuity account will grow by the end of the contract term. To calculate, all you need to know is the return rate, the amount of money in the account, and the length of the contract. That predictability allows pre-retirees to more accurately plan their retirement budgets and expenditures.
Because the Internal Revenue Service classifies annuities as retirement vehicles, like individual retirement arrangements and 401(k)s, they all grow tax-deferred, meaning that you do not pay taxes on their gains. That tax-deferred growth allows your annuity account to accrue and compound interest, which makes for faster growth over time. Only when you begin receiving disbursements do you pay taxes on each withdrawal. If you purchased a qualified annuity (one funded with pretax dollars), the withdrawals are taxed as income. If you have a non-qualified annuity (funded with post-tax dollars), only the earnings get taxed.
Relatively High Interest Rates
Fixed annuities are similar to certificates of deposit (CDs) in that they both guarantee principal protection and a specific rate of return. Where they differ, however, is in the generosity of the interest rate offered. Comparing fixed annuity rates with those of CDs, you may find that the former, on average, tends to be higher, allowing you to realize more gains on your money.
Should you pass away before or after annuitizing your contract, the money isn't lost but rather gets redirected to one or several beneficiaries that you designate. The beneficiary protection can be an attractive option if you want to help your loved ones financially when you're gone. You can also add riders, which are optional enhancements of your annuity, to increase how much your beneficiaries receive.
Liquidity is the state of being easily converted to cash. Fixed annuities offer moderate liquidity because an annuitant over the age of 59.5 has some freedom to withdraw from the account penalty-free before the end of the contract term. Typically, 10% of the annuity's value is convertible to cash under these conditions.
Even though fixed annuities are low-risk, they offer substantial rewards to those who want to retire. Indeed, investors often use them to supplement the higher-risk vehicles in their portfolio, helping to level out potential losses and avert the prospect of running out of money after they leave the workforce.
If you are interested in adding a fixed annuity to your retirement plan, consider speaking with a financial adviser today. They can guide you through the process of purchasing and funding an annuity and also outline the potential challenges it could present. Make well-informed decisions tailored to your financial needs to protect your money and your future.
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