Investing in Fixed Income Annuities

Fixed income annuities can provide financial security and stability for those nearing retirement or who are already retired. When an investor purchases a fixed annuity contract from an insurance company, the premium is most often placed in ultra-conservative mutual funds. The payments returned to the investor, either as monthly, quarterly or annual payments, are fixed. The fixed rate is typically between 3% and 5% of the principal.

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Fixed Annuities as Immediate Annuities

Because of their low growth potential and the risk of inflation, fixed income annuities are usually purchased as immediate annuities. An immediate annuity is purchased with a single lump-sum premium. (If an investor decides he or she wants to increase the size of the annuity, a new contract must be purchased.) Payments begin immediately and are guaranteed for a set number of years or the life of the owner, whichever is specified in the contract.

Immediate fixed income annuities can be purchased with the funds from any number of sources, including the proceeds from the sale of a house, an inheritance or income derived from other retirement accounts. For the retired investor, fixed income annuities provide several advantages over variable annuities, indexed annuities, mutual funds and equities.

Comparing Fixed Income Annuities to Variable Annuities

The amount of money earned on a variable annuity depends on the way in which the premium is invested. Investors usually have the option of choosing among a range of highly aggressive and ultra-conservative mutual funds. These funds can also consist of both foreign or domestic stocks and bonds.

If the goal of the investor is a high rate of growth, then he or she directs the insurance company to invest in the highly aggressive funds. Investors who choose to pursue aggressive growth also run the risk of losing capital. For those at or near retirement, this could result in a potentially harmful situation that isn’t easily corrected.

Comparing Fixed Income Annuities to Indexed Annuities

The premium paid for an indexed annuity is placed in an index fund. The most common index used for indexed annuities is the Standard and Poor’s 500. The gains and losses for an indexed annuity are tied to the rise and fall of the index. While this can provide excellent growth potential in some years, it can provide significant losses in others.

Because indexed annuities invest in the stock market, they may not be appropriate for investors without other assets. Other assets like diversified stock and bond funds, cash and real estate may help to offset any losses incurred in an indexed annuity.

Comparing Fixed Income Annuities to Mutual Funds

The income generated by a fixed income annuity is guaranteed to remain the same whether the market goes up or goes down. Mutual funds cannot make this same guarantee. Because they are made up of anywhere from tens to hundreds of stocks or bonds, they are subject to economic forces beyond an investor’s control. Further, mutual funds are typically established around specific industry sectors. If one stock within the sector loses value, it is possible for most of the rest to lose value as well.

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Comparing Fixed Income Annuities to Equities

While statistics prove that over the long term, equities provide the greatest possible chance for an increase in wealth, equities may not be a good choice for those at or near retirement. A certain amount of growth is required in any portfolio in order to offset the effects of inflation. But equities are often subject to dizzying ups and downs over short periods of time. And dividends, which can provide income, can be reduced or eliminated altogether.

For the fixed income investor looking to ensure that he or she will not lose purchasing power due to inflation over 20 or 30 years, a COLA (cost of living adjustment) rider can be purchased along with the fixed income annuity. The COLA rider will provide an increase in payments each year on order to offset inflationary pressures.

The Safety Features of Fixed Income Annuities

A fixed income annuity can provide lifetime income for either an annuity owner or both the owner and his or her spouse. It can also return a portion of the premium to a beneficiary should the owner die prematurely. Several options exist when it comes to selecting the right annuity for each investor’s situation.

Guaranteed Lifetime Income

A fixed income annuity will provide lifetime income for the owner. Payouts will be made by the insurance company no matter how long he or she lives. However, should the owner die early in the term of the contract, the premium is kept by the insurance company.

Guaranteed Lifetime Income with Return of Premium Option

This option is also known as “Life with Period Certain”. The payouts are made to the owner of the annuity just as they are with the guaranteed lifetime income option. But, should the owner die within a predetermined minimum period of time, the beneficiary will receive the remaining payouts. For example, if the period selected is 15 years, and the owner dies in year 12, payments are made to the beneficiary for three years.

Return of Initial Premium

This option also guarantees to payout as long as the original annuitant is alive. If, however, he or she dies before the original premium is paid out in its entirety, the balance is paid to the beneficiary. For example, if the original premium was $100,000 and at the time of the owner’s death he or she had received $75,000 in payouts, the beneficiary would receive $25,000.

Jointly Owned Fixed Income Annuities

Fixed income annuities can also be purchased jointly between spouses. With this option, one payout is received while both spouses are alive. Following the death of one spouse, the surviving spouse still receives a payout for as long as he or she is alive. Combined with a suitable life insurance policy, this can be an excellent way for married couples to ensure that the death of one won’t result in a lowered standard of living for the other.

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