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Understanding Fixed Annuities: Pros and Cons

Steve Scothorn

Director of Insurance Solutions

Summary

Craft your financial masterpiece: Explore a symphony of tools in financial planning by spotlighting the rhythm of fixed annuities.

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Financial planning is an art form. As with music, painting, or interior design, there are many thoughts, ideas, and tools that need to work together seamlessly to create the beautiful piece of art known as a financial plan. One of the many tools in the financial planning toolbox is an annuity, which comes in various shapes and sizes. Your specific reasons for considering an annuity can help determine which types fit your investment strategy. Here, we focus on one type: the fixed annuity.

 

What is a fixed annuity?

Think of the fixed annuity as a contract between you and an insurance company. You pay for the annuity either in a lump sum or in a series of payments within an agreed-upon time frame. Essentially, you allow the insurance company to borrow your money, earn guaranteed interest on your behalf, and return the money plus interest to you in a series of fixed payments.

The typical fixed annuity has two phases. In the accumulation phase, the initial investment sees tax-deferred growth at a fixed guaranteed-interest rate. The payments to you, known as annuity income, begin in the payout phase. Depending on the terms of the annuity, the payout phase can be over a period of years or a lifetime. The lifetime option is popular among many investors who seek financial security during their retirement years.

 

Who may need a fixed annuity?

  • Almost-retired or retired individuals
  • Risk-averse individuals
  • Those planning for future health needs
  • Individuals seeking to save on taxes
  • Anyone seeking steady income
  • Wealthy individuals planning for family

 

A timely investment

According to a 2023 report by Life Insurance Marketing and Research Association (LIMRA), fixed annuity sales have seen notable growth in recent years.1 In 2022, for example, sales rose 22% from the previous year to a new record of $310.6 billion. According to Todd Giesing, assistant vice president of LIMRA Annuity Research, “In 2023, LIMRA is forecasting [fixed indexed annuity] sales to experience moderate increases, as investors continue to seek protection and growth opportunity. We expect this growth to continue through 2025.”

A misnomer about annuities is that they’re designed primarily for longer-term investing. Yes, that’s one benefit; however, an additional advantage is that they can be optimal places for parking short-term savings, because many top-rated insurance companies have three-, five-, and seven-year fixed annuities that are offering the best interest rates in more than a decade.

 

Pros and cons of fixed annuities

While the recent increase in interest rates has boosted the allure of fixed annuities, they’re not suitable for everyone. As with any investment, prospective investors should weigh both the advantages and disadvantages:

Pros

  • The guarantee of principal and interest rate makes fixed annuities a low-stress investment that can withstand different market conditions.
  • Fixed, predictable payouts can help with budgeting and ensuring a set income over a predetermined period.
  • Tax-deferred growth means more-predictable tax planning as well.

Cons

  • Many fixed annuities, especially in the accumulation phase, have liquidity restrictions—which means access to funds is restricted or subject to penalty.
  • Compared with riskier investments, fixed annuities are capped in growth potential.
  • During lower interest-rate cycles, inflation can be a concern in the long term because the interest paid might not keep up with a rise in the cost of living and because inflation can erode purchasing power.

Weighing the disadvantages against the benefits and aligning decisions with specific goals and risk tolerance are essential when considering fixed annuities. Our advisors work in tandem with an in-house insurance solutions team to review whether a fixed annuity is appropriate for your financial plan.

Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.

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