Define Fixed Annuity

An annuity is a financial-planning tool in which an individual enters into a contract with a life insurance company that turns a short-term investment into a long-term contract. It is considered a life insurance product, but there are differences between an annuity and a traditional life insurance policy. The two types of annuities are fixed and variable, with the fixed annuity considered the safer investment.

Definition

According to Street Authority, a financial website, a fixed annuity is a retirement account in which earnings are based on a fixed rate set by the insurance company. The only serious risk with a fixed annuity is that because the rate is fixed, it cannot take into account runaway inflation. But, generally, the fixed annuity is not sensitive to market pressures, as a variable-rate annuity can be.

Fixed Annuity vs. Life Insurance Policies

Many life insurance companies offer traditional policies and annuities. There is one key difference between the two. A traditional life insurance policy is usually paid once the person has died. That money goes to a designated beneficiary. With a fixed annuity, that money is paid to the person who took out the policy at a designated time, usually at retirement. The money is paid out, with compounded interest, usually in intervals. When the owner of the annuity dies, the payouts end, unless there is a beneficiary.

Benefits of Fixed Annuities

One reason fixed annuities are popular is that the contributions to the principal investment, and the investment you earn, are tax-free until you begin to withdraw the money. Along with the consistent income that annuities provide to retirees, annuity owners can switch between annuity investments without tax penalty and they are not limited in the amount of money they can contribute.

Qualified and Non-Qualified Annuities

Fixed annuities have two subgroups regarding the income you contribute to the annuity. Qualified annuities are annuities that can be funded with either pretax dollars or with money that is exempt from taxation, similar to a 401k. Non-qualified annuities are annuities that are funded with money that has already been taxed.

Fixed Annuity at Retirement

Most of the information about fixed annuities has been in regard to deferred annuities. But retirees can also purchase what are called immediate annuities. These annuities are purchased with a lump sum of money, and then begin to pay out within a year of purchase. These immediate annuities are subject to the same tax rules.