A fixed annuity is a retirement contract between an investor and an insurance company. The funds invested in the fixed annuity grown through the accumulation period, generally at a fixed interest rate. The interest earned on the contract is tax-deferred meaning that there is no tax paid until money is taken out, typically at retirement. A fixed annuity has no market risk due to the fact that the money is not invested in the market but does have inflation risk because oftentimes the interest paid on the contract is below current inflation rates.
Annuities were originally designed to mimic pensions by providing income guarantees in retirement. Historically this was done through investors requesting to annuitize their account. Annuitizing means that the insurance company will exchange the cash value of the underlying investment for a guaranteed income stream for a term of time (usually life or longer). Once annuitized, the death benefit generally no longer exists. The guarantees are backed by the insurance company.
Since the mid-1990s annuities have offered living benefits. Living benefits are usually guarantees of income during retirement which can be utilized without having to annuitize the contract. This allows the investor to have a guaranteed income stream while retaining the death benefit feature and access to the underlying value of the assets. Distributions from the annuity greater than the amount guaranteed by the living benefit can in some cases incur additional fees and a potential reduction of the income guarantee.
Annuity distributions prior to age 59 1/2 generally incur ordinary income taxes plus a 10% penalty just like Traditional IRAs. In contrast to IRAs, annuities have no required minimum distributions.