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A fixed annuity is a contract between you and an issuer whereby you agree to give the issuer a dollar amount and in return the issuer guarantees you a rate of interest and fixed payments over time. In a fixed annuity, the issuer carries the risk of principal loss, not the contract owner. While annuities are not insurance policies, they are issued by insurance companies.
A fixed annuity is generally considered to be a good vehicle for conservative investors who may be seeking an alternative to a certificate of deposit (CD). Monies are invested by the issuer primarily in government securities and high-grade corporate bonds, and they offer guaranteed interest rates. However, unlike a CD, your money grows tax-deferred, and you may be able to secure a higher rate of interest. In return for these advantages, you give up some flexibility in terms of withdrawals and timing.
The issuer will initially declare a rate of interest that is fixed for a specified period, often a year, and then will credit "renewal" interest rates that may be higher or lower for succeeding periods. However, fixed annuity contracts should also contain a minimum rate of interest that will be paid over the life of the contract. Because the issuer guarantees these rates, fixed annuities are considered a low-risk investment. Also, because fixed annuities offer guaranteed rates of return, they differ from variable annuities, which are often modeled after publicly traded mutual funds, and which carry the risk of principal loss.
An annuity is similar to a retirement plan in that all capital in an annuity grows and compounds tax-deferred until you begin making withdrawals. Unlike retirement plans, however, there is no limit as to how much you can invest in annuities. Contributions to fixed annuities are not limited if the annuity is not part of an IRA or qualified retirement plan. You generally do not have to begin withdrawals until at least age 85. If death occurs before payments begin, the balance will pass directly to a named beneficiary.
When selecting a fixed annuity, you will need to decide on the timing of the payout—i.e., whether to purchase a "deferred" annuity (where the principal continues to grow until the investor begins receiving payments starting at some later date, usually at retirement) or an "immediate" annuity (where the investor begins to receive payments immediately).