Fixed income annuity: How it works and when it makes sense

When saving for the future, the guaranteed income associated with fixed annuities sounds appealing. These accounts can provide stability during retirement planning and help you build a predictable income stream.

While this type of annuity certainly has its benefits, it’s worth considering several options before putting all your retirement savings in one basket. These accounts have limits and won’t be the right fit for every investor. Finding the right long-term investment strategy takes research.

{{key-takeaways}}

‍

Here, you’ll learn what a fixed income annuity is, how it works, and the situations in which it’s a strong option. You’ll also see the drawbacks and a few similar investing options to consider.

What is a fixed income annuity?

A fixed income annuity is an insurance contract in which you contribute your principal and receive a fixed interest rate. When you begin withdrawals, the insurer turns your balance into a guaranteed income stream for a set period or for the rest of your life. The insurer guarantees this amount even if your contribution and the interest earned don’t fully cover the payouts after annuitization.

Fixed immediate income annuity vs. fixed deferred income annuity

Fixed immediate income annuities convert a lump sum into guaranteed income as soon as one month after an initial contribution. This is useful if you want a reliable stream of income without waiting through a long accumulation period.

With a fixed deferred income annuity, you contribute money now and receive payouts in the future. This type of fixed annuity can work well for retirement planning because savings grow tax-deferred for many years. Withdrawals before age 59½ often trigger a 10% tax penalty.

Fixed income annuity payout options: 3 common accounts

Fixed annuity payouts can last for different periods of time, depending on the structure of the account. Here are four common options.

Straight life annuity

Straight life annuities — or single life annuities — pay out to one person, meaning there are no survivor benefits. The only exception occurs when the account holder pays to add a death benefit rider to the annuity, which would guarantee payments to beneficiaries.

This type of annuity often provides higher monthly income than other accounts because the insurance company only has to pay until the account holder’s death and doesn’t extend payments to beneficiaries thereafter. These annuities for life often appeal to people who want a potentially higher income benefit now in exchange for a payout that doesn’t end until they pass.

Period-certain annuity

Period-certain — or term-certain annuities — pay out for a set number of years, often in a monthly or quarterly structure. This period is typically 10 or 20 years. If the account holder dies before the period is over, the insurance company continues to make payments to beneficiaries.

Joint and survivor annuities

Joint and survivor annuities typically cover two people, often spouses. They guarantee payouts for as long as at least one person is alive. These annuities can have lower payment amounts because the insurance company often projects a long payment period.

How fixed income annuities work: accumulation, payouts, and guarantees

The fixed income annuity account has two primary phases: accumulation and payout.

Accumulation

During accumulation, you pay a lump sum or a series of payments into the annuity, and your savings grow at a fixed interest rate. With a deferred annuity, the accumulation period can last for many years, generally until you retire or longer. With an immediate annuity, this period is much shorter. The accumulation period for this type of fixed rate annuity usually ends between one month and one year of funding the account.

Payout

During payout, you receive your principal and interest in regular payments — equal payments made at an established frequency, such as monthly, quarterly or annually. The amount of each payment depends on your life expectancy and the fixed rate on your annuity.

If you have a higher interest rate, you earn more in each payment because the account generates more predictable growth. If your life expectancy is long, your payments will likely be smaller because the insurer anticipates making more payments to you.

Fixed income annuity vs. other retirement income options

While fixed annuities offer guaranteed income and the peace of mind that comes with it, their growth potential is limited. Comparing this retirement option to other products can help you make an informed decision.

Bonds

A bond is a debt instrument you can buy from the government or a corporation. Like fixed annuities, bonds offer a conservative, guaranteed interest rate. But the payout structure is different: The issuer pays the interest earned over a fixed period before returning your principal at maturity.

CDs

Certificates of deposit (CDs) also offer conservative, fixed rates for a set period. They’re generally shorter-term investments than annuities — especially deferred ones.

CDs also differ from fixed income annuities in their distribution and taxation style. The issuer pays out CD principal and interest in a lump sum — not in a series of payments. And while certain types of fixed income annuities grow tax-deferred, the IRS taxes CD interest each year.

Systematic withdrawal plans

Systematic withdrawal plans (SWPs) are scheduled investment distributions, generally offered by mutual funds. Unlike fixed annuities, these investments don’t earn fixed returns, and their growth depends on market performance. Tax treatment is also a key differentiator: The IRS only taxes SWPs’ capital gains, while it can tax up to the full amount of annuity payouts as ordinary income.

When a fixed income annuity may make sense

Fixed income annuities are a better fit for some investors, depending on their goals and financial situation.

Near or in retirement

If you’re in retirement, you can contribute your savings in a fixed annuity and receive guaranteed payments for life, which can offer structure and predictability. And if you’re close to retiring, you have time to accumulate interest at a fixed rate on your contributions before receiving payouts.

Desire for an income floor

An income floor is a regular amount of money you receive each month. With a fixed annuity, you receive a guaranteed income stream that provides reliable payments — outside of Social Security — to cover basic expenses. Your insurer can even help you calculate the deposit needed to reach a specific income target.

Low risk tolerance

If you have a low risk tolerance, a fixed income annuity can be a solid option as payments are guaranteed at a preset amount. Your money won’t grow uncapped, but you will be able to plan your budget around known variables.

Fixed income annuity pros and cons: Key tradeoffs to weigh

Often one of the best ways to judge whether an investment option is right for you is to weigh the benefits against the tradeoffs. Here are a few pros and cons of fixed income annuities.

Pros

Perhaps the clearest benefit of this account is that you receive fixed, guaranteed retirement annuity income. Another advantage is the tax deferral structure: You often don’t pay taxes on the principal or interest during the accumulation period. In this structure, the IRS will tax withdrawals later on, but you can grow the annuity more quickly as you're contributing to it.

Cons

Fixed income annuities might not be a good choice if you’re concerned about inflation. Since you lock in your guaranteed payment when you open the account, this income floor may prove too little to reasonably support you in retirement if the cost of living rises.

Another con to consider is the lack of flexibility. Many annuity accounts have a surrender period of 6 to 8 years in which you can’t withdraw money without incurring a penalty. And the IRS has its own rules about when you can withdraw from certain types of annuities. On a deferred annuity, you’ll typically be charged a 10% tax penalty if you take out money before you reach age 59½.

Increase your financial potential with Gainbridge

Predictable income helps you plan. That reliability can be especially important when you can no longer depend on income from work.

Fixed annuities offer guaranteed income backed by an insurance company that can cover you and your beneficiaries’ needs long into the future. But they’re only one option and are often best used as part of a diversified retirement plan.

Gainbridge offers modern fixed annuities with no hidden fees or commissions. You can compare interest rate guarantees and review account features. Explore Gainbridge today to discover how our annuities can help you create a predictable retirement income alongside your broader financial strategy.

This article is intended for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. For advice concerning your own situation please contact the appropriate professional. The Gainbridge® digital platform provides informational and educational resources intended only for self-directed purposes. Save Retirement and Save Traditional are issued by Gainbridge Life Insurance Company, a Delaware-domiciled insurance company with its principal office in Zionsville, Indiana and is licensed and authorized to do business in 49 states (all states except New York) and the District of Columbia. Products and/or features may not be available in all states. Guarantees are based on the financial strength and claims paying ability of the issuing insurance company. Please visit gainbridge.com for current rates, full product disclosure and disclaimers and additional information. Withdrawals of taxable amounts are subject to ordinary income tax and if made before age 59½, may be subject to a 10% federal income tax penalty. Distributions of taxable amounts from a nonqualified annuity may also be subject to an additional 3.8% federal tax on net investment income. Because they are meant for long-term accumulation, most annuities have withdrawal charges that are assessed during the early years of the contract if the contract owner surrenders the annuity.

‍