Fixed Annuities and Your Retirement

2006-01-15

There are two main types of annuities: immediate annuities and deferred annuities. The immediate annuity is the earliest form of annuity and the first known immediate annuities date back to the 17th century. An immediate annuity is a principally a way of distributing already accumulated assets. A lump sum is invested in exchange for later pay backs that will be distributed over a predetermined period, such as 15 years or during the course of the purchaser\\\'s life time. A deferred annuity is instead chiefly a way of accumulating assets. The deferred annuity has only existed since the 1970s and deferred annuities are mainly used as way for individuals to invest money that will be used after retiring. The term ‘deferred’ in deferred annuity is derived from the fact deferred annuities are tax deferred according to U.S. tax law. There are three main types of deferred annuities: Fixed Annuities, Variable Annuities and Equity Indexed Annuity (EIA).

A fixed deferred annuity is a low risk investment, since insurance company that sells the fixed annuity will guarantee a predetermined return over the life of the contract. For this reason, fixed annuities are often compared to Bank Certificates of Deposit. Just like the other types of annuities, the fixed annuity will however receive special treatment when it comes to taxation. Since annuities, including the fixed annuities, are chiefly used as a way of providing a citizen with a pension annuities make individuals more self reliant and less likely to require state welfare. The state is therefore granting annuities favorable tax treatment. When you compare fixed annuities with other types of low risk investments, this favorable tax treatment must therefore be included in the calculations. According to the USA tax code, the value increase of your fixed annuity will not be taxed during the accumulation phase, which makes it a so called tax deferred investment. The money will however be taxed as your fixed annuity begins to pay out.

Since the fixed annuity is a safe investment with guaranteed growth rate, their prize will be similar to other forms of low risk investments, e.g. governmental bonds. Low risk does however not mean totally risk free. During the 1990s investors lost their money when an annuity provider filed bankruptcy. This was possible since the money were not held in trust. Many fixed annuity providers will invest the money in funds that have incorporated some type of protection against bankruptcy, e.g. derivatives.

A lot of the fixed annuities available today do not have an absolutely fixed return rate. Instead, the insurance company will offer the purchaser of a fixed annuity a guaranteed minimum rate over the life of the contract. Many insurance companies will also offer a so called “teaser rate”, which is a guaranteed growth rate of the fixed annuity that is valid only during the first year after purchasing the fixed annuity.

When you choose between different fixed annuities you should also compare the sales commissions and expense ratios for each fixed annuity. Compared to other types of investments, annuities will usually be sold with high sales commissions and the fix annuity is no exceptions to this rule. If you want to be able to withdraw money from your fixed annuity in advance, e.g. during an unforeseen emergency, this possibility should be included in the contract. Most standard contracts allow you to withdraw a certain percentage of the interest or the principal early, but only if you pay extra fees and penalties. You should also make sure that you know what will happen with your money when you die. It is common for fixed annuities to liquidize instantly at the death of the annuitant.

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