The Overview of Fixed and Variable Annuities
Fixed annuities and variable annuities both offer the potential of providing income during retirement, though their differences could make one better suited to an individual depending on their financial goals and circumstances.
Annuities that offer fixed annuities offer investors a guaranteed rate of return over an agreed term, whether this means making one lump-sum or series of payments to an insurance company, with this money then invested and paying a set interest rate over its agreed term. Fixed annuities provide investors who seek stability and reduced risk with steady streams of income.
Variable annuities provide more investment flexibility and options than fixed annuities do, without being limited by fixed return rates or return guarantees. Returns depend on performance of mutual funds or other investment vehicles used as investments within variable annuities – no fixed rate guaranteed return rate here! With potential for higher returns but greater market fluctuations risk involved with investing through variable annuities they may better suit those with long-term investment horizons who possess an increased tolerance of risk.
Annuities both fixed and variable come with their own advantages and disadvantages that depend on individual goals and needs, making an informed decision critical to reaching financial success. Before choosing one or the other it’s essential to review all features and fees associated with each type of annuity before making your selection.
Fixed Annuities
Annuities fixed are investments wherein an investor makes either one large sum payment, or multiple smaller ones over a given time, to an insurance company in exchange for investments which promise a fixed rate of return over an agreed term period. Often this means investing in conservative assets like bonds; then paying a steady interest rate over that time period back to them as promised by contract.
Fixed annuities provide a steady income source that’s unaffected by market changes or interest rate shifts – perfect for investors seeking security with minimal risk exposure. Fixed annuities often boast higher returns than savings accounts or certificates of deposit (CDs), providing another avenue to maximize savings potential.
Advantages of Fixed Annuities:
- Protect yourself against market fluctuations and risk with guaranteed rates of return for an agreed duration.
- Contributions are unlimited. Tax-deferred growth means paying taxes only when dividends are distributed.
- This way you can guarantee yourself income throughout life or for an exact period.
Disadvantages of Fixed Annuities:
- Investment options with lower returns potential than variable annuities.
- Typically incur early withdrawal penalties and surrender charges.
- Over time inflation can diminish their purchasing power and cause their purchasing power to reduce over time.
Types of Fixed Annuities:
- Annuities established through tradition: The insurer offers fixed annuity contracts that guarantee a rate of return over one to 10 years.
- Multi-Year Guaranteed Annuities (MYGAs): Similar to fixed annuities but providing longer guarantees up to 10 years or beyond are also an option.
- Fixed Index Annuities (FIAs): Fixed and variable annuities that combine market index interest rates with guaranteed minimum returns are known as Fixed Index Annuities (FIA).
Variable Annuities
An annuity with variable returns is a type of annuity with greater potential returns than fixed rate annuities, yet with increased investment risk. Individuals pay their lump-sum payment or series of payments directly to an insurance company who then invests them into mutual funds, bonds or stocks subject to market fluctuation that could cause their value to fluctuate either rise or decline over time.
Advantages of Variable Annuities:
- Fixed annuities and other conservative investments may provide greater returns than more aggressive options such as stocks or bonds.
- There are multiple mutual fund, stock and bond investment solutions available as potential choices to you when choosing investments for yourself or for others.
- Individual risk tolerance levels and investment goals can be tailored to with flexible portfolios designed to suit them;
- Tax deferred growth means taxes only become due when dividends are distributed as dividends.
- Some variable annuities offer death benefits that pay out a certain sum if an investor dies before receiving payments, providing financial security to his beneficiaries in his place.
Disadvantages of Variable Annuities:
- Fixed annuities present higher investment risks.
- Their fees and expenses, such as mortality and expense charges as well as administrative management charges can also be higher.
- Surrender charges may apply if funds are withdrawn prior to their designated term.
- Any investment losses could also occur since there is no guaranteed rate of return.
Types of Variable Annuities:
- Annuities that accumulate money: These annuities are designed for people looking to save up funds for retirement while taking advantage of market growth.
- Income annuities: Income annuities offer regular streams of income once retired individuals have established an income annuity account.
- Fixed index annuities (FIA): As noted earlier, fixed index annuities are hybrid annuities in which returns are determined by an underlying index while at the same time guaranteeing at least minimum rate of return.
Before making your selection; it’s wise to research all fees, expenses, and investment options associated with variable annuities carefully before making your choice. They tend to be much more complicated and costly than most investments.
Difference of Fixed and Variable Annuities
Variable and fixed annuities differ primarily by their respective guarantees of return, and levels of investment risk. Fixed annuities offer guaranteed rates over certain time frames while variable annuities offer potential higher returns at the expense of investment risk.
- Returns Guaranteed/Not Guaranteed: Fixed annuities offer guaranteed rates of return while variable annuities don’t provide any such guarantees; their returns depend on market performance and conditions for their investments underlying them.
- Investment Risk: Fixed annuities offer guaranteed returns that protect principal from market risk, while variable annuities may expose your principal to more dangers that could cause losses in investments.
- Investment Options: Fixed annuities have limited investment options; typically consisting of safe bonds. On the other hand, variable annuities offer more choices including mutual funds and stocks.
- Fees and Expenses: Variable annuities typically incur higher fees and costs than fixed annuities, including administrative, mortality and expense charges, investment management, as well as administrative management fees.
- Tax treatment: Fixed and variable annuities provide tax-deferred income growth; taxes only become due when distributions are made. Variable annuities tend to attract higher taxes as gains are taxed using regular income tax rates rather than capital gains tax rates.
Choice between variable and fixed annuities depends heavily upon an investor’s investment horizon and risk tolerance. Fixed annuities provide steady rates of return while variable annuities offer the possibility for greater potential return but more risk.
Which Should You Choose Fixed vs Variable Annuity?
Both variable and fixed annuities may prove valuable, in certain circumstances one may prove more suited for you than the other.
David Clausen is a wealth management advisor at Northwestern Mutual and certified financial planner. In today’s low interest rate environment, people may struggle to build up an investment ladder that will provide income without taking on excessive credit risk or endangering principal.
Variable annuities offer an attractive solution for investors willing to accept greater levels of risk or those looking for extra savings in retirement.
Even in difficult markets, your minimum benefit still provides income that helps protect principal. By maintaining that source of revenue even during times of economic turmoil, minimum benefits remain an effective tool in protecting principal.
Focusing on your risk tolerance and any gaps you need to fill when choosing an annuity that best meets your retirement planning needs can help guide the decision process.
Clausen notes that when selecting an annuity type for clients, two major considerations include their risk tolerance and what role other assets will play in their plan. Annuities are an effective tool that can supplement existing planning as well as any gaps, making identifying any such instances the first step of choosing your annuity type.
Conclusion
Understanding the differences between Fixed and Variable annuities is vital for making informed financial decisions. While fixed elements provide predictability and stability, variable elements introduce dynamism and potential risks. By balancing both in financial planning and investment strategies, individuals and businesses can achieve greater financial success and resilience.
