What Is a Fixed Annuity?

A fixed annuity is a type of insurance contract that promises to pay the buyer a specific, guaranteed interest rate on their contributions to the account. By contrast, a variable annuity pays interest that can fluctuate based on the performance of an investment portfolio chosen by the account's owner. Fixed annuities are often used in retirement planning.

Key Takeaways

Fixed annuities are insurance contracts that pay a guaranteed rate of interest on the account owner's contributions.

Variable annuities, by contrast, pay a rate that varies according to the performance of an investment portfolio chosen by the account owner.

The earnings in a fixed annuity are tax deferred until the owner begins receiving income from the annuity.



How a Fixed Annuity Works

Investors can buy a fixed annuity with either a lump sum of money or a series of payments over time. The insurance company, in turn, guarantees that the account will earn a certain rate of interest. This period is known as the accumulation phase.

 When the annuity owner, or annuitant, elects to begin receiving regular income from the annuity, the insurance company calculates those payments based on the amount of money in the account, the owner's age, how long the payments are to continue, and other factors. This begins the payout phase. The payout phase may continue for a specified number of years or for the rest of the owner's life.

During the accumulation phase, the account grows tax-deferred. Then the account holder annuitizes the contract, distributions are taxed based on an exclusion ratio. This is the ratio of the account holder's premium payments to the to the amount accumulated in the account that is based on gains from the interest earned during the accumulation phase. The premiums paid are excluded and the portion attributable to gains is taxed. This is often expressed as a percentage.

This situation applies to non-qualified annuities, which are those not held in a qualified retirement plan. In the case of a qualified annuity, the entire payment would be subject to taxes.

Content was sited from Investopedia's article on Fixed Annuity

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