Fixed Rate Vs. Variable Annuities

Annuities are insurance products in which the annuity-holder makes a payment or a number of payments to the company offering the annuities, in exchange for a guaranteed stream of income for the rest of the his or her life or up to a pre-agreed expiry date of the annuity.

Based on their returns (the stream of income from an annuity), annuities are classified as either fixed rate or variable rate annuities.

In fixed rate annuities, the annuitant is guaranteed of a fixed rate of income from the annuity, regardless of the performance of the investments into which the annuity premium is invested. On the other hand, returns from variable annuities vary depending on the performance of the investments into which the annuity premium is invested. Both fixed rate and variable annuities have their unique advantages and disadvantages.

The main advantage of fixed rate annuities lies in their security and low risk. This is to say that regardless of the performance of their underlying investments, the annuity-holder is always assured of a continuous stream of income, often for a lifetime. Thus fixed rate annuities can be ideal for retirees and other risk-averse people who don’t want to subject themselves to the rigors of investment. With fixed rate annuities, you get a reasonable return on your annuity investment without exposing yourself to the investment risk.

Conversely, the downside to fixed rate annuities is the fact that they offer limited room for growth, and regardless of how well the investments made using your annuity premium performs, you still get a fixed return from it. Moreover, opting for a fixed rate annuity could bar you from taking advantage of some tax deferment benefits available to variable annuity holders.

Turning to variable annuities, their main advantage is the room for growth they offer, which could potentially translate into significantly higher returns in the long run. Moreover, returns from variable annuities are often subject to tax deferment benefits. The downside to variable annuities is the fact variable rate annuities expose the annuity-holder to the investment risk, and if the investments made using the annuity premium perform poorly, the annuity holder could end up seeing a significantly diminished stream of income from the annuity.

Now such a diminishing stream of income is probably the very last thing you would want to hear in the middle of your retirement, especially if the annuity is your only source of steady income at that point.