What is a Fixed Annuities

The basic premise of a fixed annuity is that you give a sum of money to an insurance company, and in exchange they promise to pay you a fixed monthly amount for a certain period of time. In the case of a single premium immediate annuity (SPIA), the payments begin immediately. In the case of a single premium deferred annuity (SPDA), the payments begin at a date of your choice, for example at your retirement. So these vehicles can be used as tax-deferred investments, or can be seen as a way to convert a lump sum into an income stream.

Once annuity payments begin, they do not change, even to account for inflation. A fixed-annuity investor has two choices for the term of the payment stream:

• You can specify a fixed period, for example 10 years, meaning that payments will be made for 10 years to you (or your heirs). These payments generally are a combination of principal and interest. If instead of immediate payout you choose deferred payout, the investment grows with taxes deferred on that growth, and of course the payments begin at the chosen date.
• You can annuitize. To annuitize means you are telling the annuity company that you want to receive payments until death (i.e., specify the period to be your time on earth). And after that time is done, your heirs do not receive anything back. It doesn't matter if the payments are made for 1 month or 40 years, they stay the same provided the company stays in business, and they stop at the investor's death. Annuitization is optional but arguably the most important angle to these investments, and explains why these investments are sold by companies with experience in figuring out how long the investor (sometimes called the annuitant) will live.

A fixed annuity may have various surrender provisions that prevent you from withdrawing money for a period of 5, 10, or more years. However, depending on the company, fixed annuities may allow you some access to your investment; commonly the investor can withdraw annually the interest and up to 10% of the principal. An annuity may also have various hardship clauses that allow you to withdraw the investment with no surrender charge in certain situations, so be sure to read the fine print.

When considering a fixed annuity, compare it with a ladder of high-grade bonds that allow you to keep your principal with minimal restrictions on accessing your money. But this is not the only factor to consider. Annuitization (choosing an income stream for life) can work well for a long-lived retiree. In fact, a fixed annuity can be thought of as a kind of reverse life-insurance policy. Where a life insurance contract offers protection against premature death, the annuity contract offers protection against premature poverty; i.e., it addresses the risk of someone out-living a lump sum that they have accumulated. So when considering annuities, you might want to remember one of the original needs that annuitities were created to address, namely to offer protection against longevity.

Another situation in which a fixed annuity might have advantages is if you wish to generate monthly income and are extremely worried about loss of your capital (or somone else's risk of losing their money), for example in a lawsuit. If this is the case, for whatever reason, then giving the capital to an insurance company for management might be attractive. Of course a decent trust and trustee could probably do as well.