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Fixed Annuities vs. Variable AnnuitiesThere are different types of annuities, even though they have the same general goal: to provide a safe long-term investment. You can purchase fixed annuities and variable annuities, and their characteristics vary. Fixed annuities make less risky investments, mostly staying in the account of the financial institution and being used to buy bonds. In a variable annuity, the money is put into other financial tools and the risk is greater.
Fixed AnnuitiesThere is a fixed interest rate in a fixed annuity, which is locked in for the first year. While it can vary after that, it will have a guaranteed minimum. As a result,you can safely count on a reliable return on your investment. Fixed annuities also promise that you will not lose your principal unless the insurance company as a whole goes bankrupt.
Within fixed annuities, you have the options to receive your money in a large lump sum if you prefer. On the other hand, you can also decide to take it out in a pre-determined set of periodic payments until the annuity account is empty.Finally, you can opt to annuitize the payments. This gives you the choice to receive monthly payments for a defined period of time, which can be set to the rest of your life and the life of your spouse. In this case, you can continue to receive payouts even if you surpass the amount of money that you invested and the return on your investment. This minimizes your risk relative to other options.
Risks in Fixed Annuities
- You do still face the risk that the provider of the annuity will fail, and they are not guaranteed by any federal organization.
- You could also lose out on your spending power if the fixed rate you are guaranteed is lower than the rate of inflation.
- In some cases, the company providing the annuity will not have to pay the surviving spouse if the owner of the policy dies after receiving a small number of payments.
Variable AnnuitiesIn a variable annuity, the interest rates can change and they are not guaranteed. In addition, there is more risk involved as the money that you pay into a variable annuity can be put into different subaccounts. You do determine the level of risk that you want to take on, and from there the performance of the investment is going to be critical to your financial well-being.
You do receive tax-deferred growth within a variable annuity, and you can invest as much as you would like in a given year and still receive tax-deferred status. This is in contrast to, for example, an IRA or a Roth IRA, which has an annual contribution limit.
Since the money in your variable annuity account is always connected to a variety of other financial products, however, the level of risk is substantially higher. With that said, there are protections that can be put into place in the event that the owner of the policy loses out on the investments or lives longer than expected. This provides some additional insurance and security over a basic variable annuity.