What Is the Difference Between a Fixed and Variable Annuity?

The annuity is a very unique type of investment. Instead of a bank or stock broker, investors obtain annuities through an insurance company. And while annuities have certain things in common with life insurance, they are not the same thing. They offer low risk while providing an opportunity to receive guaranteed income for a given number of years, or even for the rest of your life.

Annuities come in many different flavors. There are immediate annuities, which begin immediately after the annuity is purchased, and deferred annuities, which may begin years or decades later. Fixed period annuities pay out for a specified period of time, while lifetime annuities pay out until the annuity holder (and in some cases the annuity holder’s spouse) dies. Single premium annuities are paid for in one lump sum, and flexible premium annuities are funded by a series of payments over time. And then there are fixed and variable annuities.

Fixed Annuities

Fixed annuities are known for being safe, stable investments. The issuing insurance company guarantees the principal of fixed annuities, as well as a minimum rate of return. Growth in value is fixed at a given interest rate or dollar amount, or determined by a formula disclosed when the investor purchases the annuity.

Growth of fixed annuities is not always limited to the minimum interest rate. When an insurance company experiences unexpectedly high growth on annuity investments, it may pass that growth on to holders of fixed annuities in the form of dividends. Terms and conditions related to such dividends should be outlined in your annuity contract.

Variable Annuities

Variable annuities have more in common with mutual funds than fixed annuities. Money put into a variable annuity is invested in a fund with a particular investment objective. Like retirement accounts, variable annuities usually offer investors a choice of funds with varying degrees of risk.

Unlike fixed annuities, the payments distributed through variable annuities fluctuate according to fund performance. When the fund performs poorly, your payment decreases. When it performs well, it increases. There is no guaranteed rate of interest, and it is possible to lose principal with this type of annuity.

Variable annuities often come with a death benefit. That means that you can designate a beneficiary to receive the greater of your account balance or a guaranteed minimum. This prevents the loss of money invested if you die before withdrawing all of the money in your account.

Fixed and variable annuities each have certain benefits. Which one is best for a given investor depends on his goals and tolerance for risk. If you’re looking for a safe, guaranteed investment, a fixed annuity may be the best choice. If you want to maximize your potential for returns, a variable annuity might be better for you.