Chapter 5. Fixed Annuities

Not all alternative investments are as exciting as commodities. In fact, the tried and true investments with the greatest long-term success are often downright boring! Perhaps the most boring of all alternative investments are fixed annuities.

A fixed annuity is a contract sold by an insurance company. The contract guarantees a fixed periodic payment over the life of the annuitant(s). The payments can begin either immediately, for an immediate annuity, or at some point in the future, for a deferred annuity.

A fixed annuity is not an investment vehicle. The issuer of the contract, the insurance company, is taking the investment risks. The only investment risk borne by the purchaser of the annuity is the risk of default by the issuer of the contract. In contrast, variable annuities, which we discuss in Chapter 17, are investment vehicles.

To explain immediate fixed annuities, we will first contrast them with deferred variable annuities. With a deferred variable annuity, investors place—either today or over a period of time—a portion of the annuity money in underlying mutual-fund-like investments called subaccounts. These subaccounts generally hold portfolios of stocks, bonds, or a combination of both. The money then grows— hopefully—over time. Withdrawals begin, free of penalty, starting at age fifty-nine and a half. No taxes are due until withdrawals begin. When money is withdrawn, investment gains, if any, are taxed at ordinary income rates. Those who are ...

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