Based on the growth potential, there are two types of annuities—fixed and variable. When making a decision on whether to buy an annuity, it becomes important to comprehend and compare the characteristics of fixed and variable annuities.
Both fixed and variable annuities can potentially provide an income that can support an individual or a couple during their retirement period; comprehending the differences between them can assist in making sure the best product is selected to meet the financial status and retirement requirements.
What is a Fixed Annuity?
An insurance provider provides a fixed annuity plan in return for a single payment (SPIA) or multiple installments (Laddering MYGAs). It is a secure option to invest money with a predetermined return rate, and it is associated with low risk. Although fixed annuities offer slightly higher interest than other traditional fixed-income investments like a traditional savings account, the returns are typically lower than what you can earn with a fluctuating annuity. Similar to a fixed-income investment, the interest rate established at the time of purchase determines the payments you receive.
When you invest in a fixed annuity, you get the assurance that the sum you’ve put in is protected, even if the stock market fluctuates drastically. Your investments are protected from market risks, but the default risk still exists. In case the insurance company goes down, it is possible that you might lose some or all of your investment—very low probability, but still worth considering.
What Is a Variable Annuity?
Variable annuities are insurance products allowing investing fixed amounts or series of payments in portfolios of stocks, bonds, or funds. You will have the opportunity to earn higher returns, but you will also be exposed to market risks.
The amount of payout you receive in a variable annuity depends on the performance of the underlying investment. A rising market will increase annuity payments. In a declining market, payments decrease.
It is important to note that in a variable annuity, you have both market and default risk. By taking the market risk, you can be rewarded with a higher return than a typical fixed annuity.
How Do They Compare?
The main difference between fixed and variable annuities is the rate of interest, and how they invest the proceeds they get from your insurance premiums.
Fixed annuities (like MYGAs) guarantee fixed rates of return based on the interest rate set at contract signing. Insurance companies typically invest the proceeds from a fixed annuity in low-risk avenues. Even if the market fluctuates, your interest credits and interest rate do not change. This is very similar to fixed-income investments like CDs, Bonds, etc.
In variable annuities, returns are linked to the underlying investment. If your investment portfolio performs well, you can get higher returns than a fixed annuity. However, returns may vary depending on the investment performance.
Which Is Right For You?
The answer to this question ultimately depends on your individual situation. The best option depends on your risk appetite, investment goals and financial situation. A fixed annuity is the best option if you want the security of a guaranteed return. However, if you are willing to take on more risk in exchange for potentially larger rewards, a variable annuity may be a better choice. To better understand the differences and determine which annuity is best for you, talk to your trusted financial advisor.