Types

• There are two types of fixed annuities, immediate and deferred. Immediate annuities provide a guaranteed income for a set period of time or for your entire life, whichever you choose. A deferred annuity defers this guaranteed payment, allowing you to build up savings over time before electing to receive payments.
  
  

Function

• Fixed annuities invest in bonds and other income-producing assets. Bonds are debt instruments, called loans. When the insurance company buys a bond to secure the interest payments in an annuity, it lends your money to a corporation or to the government. In return, the company or government pays interest on that loan. That interest is then credited to your annuity contract.
  
  

Significance

• Fixed annuities are taxed as investment income subject to ordinary income tax when you withdraw money from them. This differs from other investments. Ordinarily, investments are taxed at capital gains tax rates, which are lower than income tax rates. However, the annuity receives a favorable tax status as long as money is kept inside of the annuity. As long as you do not remove money from the annuity, there is no tax due on your savings.
  
  

Disadvantages

• The disadvantage to a fixed annuity is that you will, all other things being equal, pay more in taxes than you will with other investments. This is because capital gains tax rates are lower than ordinary income tax rates. Because of this, you'll have less income during retirement if you elect to make withdrawals from your annuity. Even if you convert your savings to guaranteed income payments, a portion of the payment will be interest and subject to income tax.
  
  

Considerations

• If you don't want to be taxed at ordinary income tax rates, consider buying a fixed annuity inside of a Roth IRA. Roth IRA accounts are not subject to income taxes when you make withdrawals from the account. This means that you get the benefits of the fixed annuity without any of negative tax consequences.