Fixed Annuity – Explained

A fixed annuity is a financial instrument that is issued by insurance companies. It is very similar to the CDs offered by banks. These instruments pay a guaranteed rate of interest and it can provide a regular stream of income for investors. It is mainly used by retired people as an extra source of income because of the predictability and guarantee. They can get this revenue through their entire lifetime.
Advantages
Fixed annuities have many advantages. Primarily, it is a guaranteed amount of income, unlike stock market returns that are subject to many ups and downs. Another advantage is that the investor need not pay tax on the interest received and the investment amounts are very low, typically starting from about $1000. These advantages make it ideal for small investors who are looking for some regular income.
Disadvantages
Despite the above-mentioned advantages, fixed annuities have their downside too. The fixed payments may not keep pace with the inflation and this in turn can substantially reduce the buying power of investors over a period of time. For example, if the rate of interest is 3% per year and the inflation is about 2% every year, then the amount of things that the interest can buy will reduce in a few years. This is a major concern for people who plan to retire early. Another disadvantage is that the rate of interest can go down after a fixed period of time. So, the amount of monthly payments can reduce. Also, there are very big charges for early withdrawal and as a result, the investor cannot withdraw money for any reason. This drastically reduces the liquidity position of the investor.
In short, this avenue of investment has its pros and cons and an individual must decide based on his or her financial needs and investment levels. It can be a great source of income for people who are planning to invest large amounts of money because the interest will cover their basic living expenses for their lifetime, even after adjusting for inflation.