Understanding Annuities: Fixed Vs. Variable

Posted on: 3 December 2015

Annuities provide another investment option for your retirement plan and can be a useful product to take advantage of that offers benefits not found in IRA's or traditional brokerage accounts. They can be a confusing product to understand so it is always a good idea to consult the advice of a financial advisor before making any decisions about your retirement plan.

An annuity is a life insurance product that allows you (the annuitant) to receive a guaranteed stream of income during your retirement years by paying into the annuity with either regular payments or larger investments, which can be contributed at the investors choosing. Payments are placed into an investment portfolio offered by the insurance company and are allowed to accumulate before distribution to the annuitant. 

They can be constructed in many different ways depending on the insurance company you choose to enter into the contract with, however, they are always offered as a retirement plan and are therefore subject to penalty should the annuitant choose to claim their money before the stated retirement age.

As annuities are a life insurance product, they frequently come with the added element of a death benefit – a payment made out to a specific beneficiary should the insured die. 

Annuities come in different forms, but the most popular are fixed or variable.

Fixed Annuities

With a fixed annuity, the insurance company will agree to pay you a fixed amount of money based on your contributions to the plan and your life expectancy. The benefits of this are guaranteed money of a certain amount, which can provide a nice security blanket for somebody in retirement. Additionally, should the financial markets go through a recession your money will not be put at risk and won't depreciate. Conversely, if the markets go through a strong growth period, your money will not receive those added benefits. 

Variable Annuities

A variable annuity is a more risky product that allows the annuitant to have control over the way their contributions are invested during the investment period. The insurance company will offer you a series of mutual funds of their choosing and you will have control over which funds your money is invested into and at what amount. With this plan, you take on the opposite risks of a fixed annuity. If the financial markets dip or go into a recession then you risk losing gains or principal. However, if the markets rise then the annuitant's investment can appreciate and the distribution value can be higher at retirement.