Fixed Annuity vs. Variable Annuity
Choosing the right type of annuity is important. This comparison of fixed and variable annuities is designed to help you figure out which one is going to help you the most and get you started in the right direction. This Fixed Annuity vs. Variable Annuity will hopefully help you make the right decision.
Who are Fixed Annuities For? Fixed annuities are designed for individuals that are adverse to risk. Typically, this includes people looking for greater returns than a money market or savings account can provide. Elderly individuals make up the majority of those in this category, but they are not the only ones who can benefit from fixed annuities. If someone has a large portfolio, a fixed annuity can also be helpful as it alleviates overall risk in the portfolio and can even allow the investor to speculate in riskier investments with other parts of their cash.
Fixed annuities can be purchased with either a lump sum or a regular payment schedule. A lot of people use lump sum payments with fixed annuities because of their nature, however. For example, if you have reached the age of 70 ½, you are required by federal law to begin taking distributions from retirement accounts, such as IRAs. Many find that it is best to transfer their IRAs into an annuity because there are no distribution ages with IRAs. Of course, the tax side of this must be looked at along with a variety of other factors. If you have questions about this, speak with a tax professional to help in this respect.
Other people that may use fixed annuities include those that have won a large sum of money, either through the lottery, a casino, a lawsuit, or something else. Turning a large amount of cash into a consistent monthly check can be a big help for managing day-to-day finances without running the risk of wasting your money.
Payout Type: Fixed annuities can either be immediate or deferred annuities. Payouts can begin right away, or they might not begin for many years. As an investor, you have the right to choose which one is best for you. Be sure to see what the insurance company’s policies are regarding payouts before you sign anything so that you know what all of your options are before you commit to anything.
Investment Type: Usually, insurance companies focus mainly on bonds and high dividend stocks when your money is in a fixed annuity. Bonds usually provide a lot less income than the overall market, but they are a lot more consistent. That’s why a fixed annuity can guarantee that you will see a 2 percent increase in your money each year. You won’t see the big ups that the stock market is capable of providing, but you also won’t see any losses.
Risks of Fixed Annuities: Fixed annuities are used because they are considered “safe,” but just like any type of investment, there are some risks involved. These include:
- An inability to keep up with growth—Fixed annuities tend to see a rate of growth that is lower than what the overall economy experiences.
- Riders can be expensive—Because growth is limited, if you want to leave a lifelong income for a spouse, the rider needed to make this happen can have an inflated cost associated with it.
- Guaranteed rates are not guaranteed by the government—Even though your insurance company gives you a guaranteed rate, this is not backed by the government. If the insurance company were to go out of business after a couple years, a lot of potential for earning power vanishes. The hassle of re-investing your money exists, too.
- Surrender fees can impact earnings—Depending on the policy, if you withdraw money in the first ten years of a fixed annuity, you may be responsible for surrender fees. Before you commit to a policy, be sure to look into these so that you know what you are facing in the event that this needs to happen.
Other Considerations: One of the good things that have developed over the course of the last several years is a hybrid fixed annuity that can help your money grow at a quicker rate than the traditional fixed annuities that used to be all you could find. These are called structured annuities, and they work by giving you the loss protection that many people go to fixed annuities for, while still maintaining some of the growth that variable annuities offer (see below for more details on this type of annuity).
Structured annuities will have a maximum loss number built into them, while still giving you the ability to keep up with the markets. For example, you can buy a structured annuity that is guaranteed to lose less than 5 percent, but cannot grow more than 8 percent. Although this is not technically a fixed annuity, it attempts to give you the benefits of a fixed annuity and a variable annuity rolled into one.
Fixed annuities have several options for riders, so it is good to know what you want and then take a look at what is offered before you finalize your selection. This will help make your search easier by narrowing down your choices of companies and annuity types before you get too deep into your search.
Who are Variable Annuities For? Variable annuities tend to be geared more toward younger people who are trying to protect and grow their money for the future. Variable annuities do their best to keep up with the overall markets over the course of their growth phase, but as a result of this, they do see similar ups and downs as to what the overall market sees. If the stock market is in a bear or recession phase, variable annuities can lose money. However, younger individuals have a lifetime of earning money and saving more money ahead of them, and the temporary losses that variable annuities can face are more than made up for if a consistent approach to investing is taken. You might see losses extend for a few years at times, but because the market’s overall direction is upward, these losses are recouped if a long term approach is taken.
Variable annuities can be purchased either as a lump sum or as a regular payment over the period of many years. Because of their nature, variable annuities tend to be paid for gradually and accumulate growth over extended periods of time. Variable annuities need an extended period of time to make growth worthwhile, and if money is leaving the account right away, this becomes increasingly difficult to make beneficial. Short term variations in the stock market can even make immediate annuities become an overall loss.
For this reason, younger professionals tend to benefit the most from variable annuities. However, it’s important to know what your goals are and speak with a professional if you have questions about how to achieve those goals.
Payout Type: Just like fixed annuities, variable annuities can be immediate or deferred annuities. Payouts can begin right away, or they might not begin for many years. As an investor, you have the right to choose which one is best for you. Be sure to see what the insurance company’s policies are regarding payouts before you sign anything so that you know what all of your options are before you commit to anything.
Immediate payments are utilized very rarely with variable annuities because of how they accumulate growth. Because they work best as long term investments, investors tend to use them as immediate annuities very seldomly. There is some potential here, especially with larger amounts of money, but this is not usually the case. Speak with a financial professional if you have more questions regarding this.
Investment Type: Insurance companies have a lot more leeway when it comes to the type of investment that they will focus on when they use a variable annuity. Your goal is more long term growth here, and for that reason, a lot of variable annuities focus on mutual funds, but you will also see traditional stocks, precious metals, or even riskier investments. You will also see bonds, money market funds, and a lot of the same things that you see in a variable annuity. Although the goal is growth, elements of stability also need to be considered for a balanced portfolio.
Risks of Variable Annuities: Just like any type of investment, variable annuities do carry risk with them. Some of these include:
- The potential to lose money—Variable annuities are connected to other assets. They can lose money, especially after fees are taken into account.
- There’s the chance that you can run out of money—Because of the potential for losses, it is possible to run out of money before you begin withdrawals. This can be avoided with the purchase of different riders, but this will increase the amount of fees that you pay, and thus impact the amount of money that you can invest and grow.
- Variable annuities tend to have higher fees—Because there is more for fund managers to watch over, variable annuities tend to have higher fees than fixed annuities. For example, administrative fees can be a lot higher here. This is in exchange for the higher returns that these annuities are capable of providing, but it can be burdensome.
Other Considerations: Variable annuities come in many types. In fact, there are so many variable annuity types that some companies actually classify these in a different manner. For example, equity indexed annuities are technically variable annuities, but because they are connected to a major index, like the S&P 500, they are designed to more closely mirror the overall economy than the typical variable annuity is.
Investors also need to remember that not all variable annuities are the same. You have some control over what the insurance company will do with your money, but it will vary. Ideally, you want to work with a company and an annuity that has the ability to change as your needs change.
Like fixed annuities, there are a lot of riders and add-ons to choose from. Have a good idea of what you’re looking for and what your goals are before you start your search. This will help you to narrow down the selection and prevent your search from being too overwhelming right off the bat.
Always remember the risk of investing and speak to the proper people about making this type of move. We hope this Fixed Annuity vs. Variable Annuity article drummed up some ideas on what you want to do going forward. There are a lot of options out there. Try to keep things simple if you can.