What Is the Difference between a Fixed and Variable Annuity?

Fixed and variable annuities are popular tools for a reliable stream of income. An annuity is essentially a contract between a purchaser and an insurance company that offers regular payments in return for a lump sum known as the principal amount. They can be structured such that the payments are fixed, meaning that each payment will provide the exact same amount, or variable, meaning that the payments can fluctuate according to market conditions.

The payment amount that the insurance company provides for both a fixed and variable annuity is agreed upon at the time of purchase and is based upon a number of factors. The purchaser’s age, prevailing interest rates at the time of purchase, the purchaser’s place of residence, and the amount of the principal that the purchaser turns over to the company all affect payment amounts. When considering the differences between a fixed and variable annuity, the key factor that determines payment amounts is the health of the investment portfolio associated with a variable annuity.

Fixed annuities are similar to a traditional pension structure, where a known amount is paid on a regular schedule. This amount is always the same, regardless of market conditions. Inflation will diminish the purchasing power of the fixed payment over time.

A variable annuity also pays regularly. The difference between a fixed and variable annuity regular payment is that the amount of the payment can vary according to the performance of financial markets or indexes. This provides the purchaser an opportunity to receive larger payments in positive economic conditions when markets are performing well. It can also mean that payments are reduced during times of poor economic performance, when markets are trending downward. Variable annuities do offer certain safeguards that can be negotiated to ensure a minimum payment amount regardless of market conditions. This can be attractive because purchasers are assured a minimum amount per payment with the opportunity for increased amounts as market performance improves.

With both fixed and variable annuity structures, purchasers have the option of choosing a lifetime payment period or a specific payment time period. If a specific payment period is chosen, payments cease after the allotted amount of years and the contract is concluded. In both a fixed and variably annuity situation, an alternate payee can be chosen in the event of the purchaser's death. Generally speaking, fixed payment periods provide larger payments than lifetime payment periods, and plans with an alternate payee provide a lower payment amount.