Fixed annuities are often misunderstood, yet they hold significant value for those who seek a stable and predictable income stream. Whether you’re planning for retirement or simply looking for a safe investment, understanding fixed annuities can be beneficial. Eric Hogarth, CFP® joined Better Money this week to dive into the pros and cons with Kara Sundlun.

The Pros of Fixed Annuities

Guaranteed Minimum Interest Rate

One of the main attractions of fixed annuities is their guaranteed minimum interest rate. Similar to a Certificate of Deposit (CD), you can lock in a good rate for a period of time, often longer than a typical CD. This ensures that you receive a steady income without worrying about market fluctuations.

Tax-Deferred Growth

Fixed annuities allow your invested money to grow tax-deferred. This means you won’t pay taxes on the interest earned until you withdraw the money. The power of compound interest, which Einstein dubbed one of the wonders of the world, becomes even more significant in this context as your investment grows unhindered by immediate tax implications.

No Risk of Loss

Fixed annuities guarantee that there’s no risk of losing your principal. Unlike other types of annuities, which may come with risks of loss, fixed annuities provide peace of mind by ensuring your investment is secure.

Reliable Retirement Income

With fixed annuities, you know exactly what you’re getting, which allows you to build a solid financial plan around this predictable income. This reliability is crucial for retirees who rely on a stable revenue stream.

The Cons of Fixed Annuities

Inflation Risk

One significant drawback is the exposure to inflation risk. For instance, if you have a fixed rate for five years at 5% and the market rates go up to 8%, you’re stuck with your lower rate. This can be detrimental in times of rising inflation when your fixed interest doesn’t keep pace with the increased cost of living.

Limited Access to Money

When you invest in a fixed annuity, you tie up your money for the agreed period. Insurance companies offer these products because they want the use of your funds. If you need to access your money before the contract ends, you may face hefty penalties, making it a less flexible investment.

Potential Fees

While some annuities come with low or no fees, others can have substantial costs associated with them. Even if there are no direct fees, the penalty for early withdrawal can be considered as an indirect cost. Always ensure you are fully informed about any fees or penalties before investing.

The Bottom Line of Fixed Annuities

Fixed annuities can be excellent tools for financial planning, particularly for those looking for a stable and predictable income source. However, it’s crucial to understand both the advantages and disadvantages before committing.

Each investment carries its own set of risks and rewards, and being well-informed will help you make the best decision for your financial future. Always consult with a financial advisor to ensure that a fixed annuity aligns with your overall investment strategy and retirement goals.