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Pros and Cons of Adding a Fixed Annuity to Your Retirement Portfolio

Senior citizen checking his annuity.

A fixed annuity is a popular source of retirement income. This insurance contract can pay you a guaranteed interest rate on your contributions, and your earnings could also grow tax-deferred until you start collecting income. But is this a good investment for your retirement? Let’s take a look at the pros and cons of buying a fixed annuity

A financial advisor can help you find additional sources of income for your retirement portfolio.

How Fixed Annuities Work

A fixed annuity is an insurance contract that pays a specific interest rate based on account contributions. You can buy a fixed annuity with a lump sum payment or a series of payments over time. 

The insurance company typically guarantees an interest rate during an accumulation phase of the annuity, which is the timeframe when you’ll make deposits to build up the cash value of your contract. This is followed by the annuitization phase, which is when you’ll start getting payments from your annuity investment.

Your accumulation phase starts when you make your first contribution and ends when you take your first distribution. Generally, the longer your accumulation phase lasts, the more time you’ll have to earn compound interest.

4 Reasons Why You Should Get a Fixed Annuity

  • You will get regular payments. A fixed annuity can pay you over a specific period of time or the rest of your lifetime. Take note, however, that the value and frequency of those payments will depend on the type of annuity that you buy and the terms of the contract. 
  • You will have a guaranteed rate. Investments always carry a certain level of risk. But, your fixed annuity contract will guarantee that you make a percentage of your principal investment, which even though it could be low, still adds up to more than what you invested.  
  • Your contributions can grow tax-deferred. The money that you put into an annuity is tax-deferred, which means that your contributions can earn compound interest without paying taxes. And you will only get taxed if you make a withdrawal or receive an annuity payment.  
  • You can pass money to your heirs. Many fixed annuity contracts include death benefits, which can get paid to your beneficiaries in the event of your death. You may have to pay an additional fee for optional death benefits that require a rider.

4 Reasons Why You May Not Want a Fixed Annuity

Man calculates his future income stream to determine if he needs an annuity.
  • Your annuity is illiquid. Fixed annuities typically limit your withdrawals to one per year, up to a certain percentage of your account value. So, if you intend to use your contribution money to pay for an emergency, you will need to have another asset or security that you can change fast for cash.
  • Your fixed return may not keep pace with inflation. Because this annuity contract is based on a fixed rate of return, your income payments will not get adjusted for inflation. So, if your cost of living spikes up, you may have to tighten your retirement budget.
  • You may have to pay a surrender charge. Depending on the terms of your annuity, you’ll have a surrender period that will last a number of years. During this time, you’ll be required to wait until you can make withdrawals, or potentially pay a surrender charge for money taken out above a maximum percentage.
  • Fees could be higher than other options. When compared with other retirement income options, annuities can carry higher fees. Therefore, you should look at different contracts since fees can vary from one insurance provider to another.

Additional Retirement Income Streams

There are other income streams that you can add to your portfolio. These include 401(k)s, which allow you to make tax-deferred contributions based on your paycheck; individual retirement accounts (IRAs) that can be funded with pretax or after-tax money; and Social Security, which gets automatically deducted from your paycheck as well. 

You can also build up your retirement nest egg with an investment portfolio that could hold a mix of assets, including stocks, bonds, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and certificates of deposit (CDs), among other options.

Bottom Line

Young woman looks at various annuities on the internet.

Buying a fixed annuity can help boost your nest egg. But before you invest in a contract, make sure you review the fees and terms to ensure that it’s a good fit for your retirement plan. 

Retirement Savings for Beginners

  • A financial advisor can help you create a financial plan for your retirement goals. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • If you want to figure out how much you should be saving for retirement, SmartAsset’s free retirement calculator can help you get an estimate based on your expected retirement age, annual income and retirement expenses.

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