As a financial product primarily designed to create guaranteed lifetime income, annuities are long-term investment products. To offer such a guarantee, annuities must be safer than other financial instruments. However, not all annuities are equal. Financial experts typically recommend fixed annuities since they are safer and more reliable than variable annuities. Just how safe are fixed annuities? The answer to that simple question can be as complicated as some annuity contracts.

No investment is totally safe and secure, particularly in the broader context of financial risk. In addition, even annuity providers can fail in certain circumstances. However, fixed annuities can be low-risk or virtually no-risk in certain cases based on several criteria:

1) Guarantees offered

2) Regulation and compliance

3) Rate of return

4) Annuity-provider strength

Guarantees offered

Fixed annuities normally offer guarantees on capital and interest rates. This feature makes fixed annuities virtually no-risk investments. The guarantee offered by insurers or annuity providers is based on the premise that assets are set aside to meet liabilities to annuitants. Even if an annuity provider becomes insolvent or illiquid, annuity regulators can use a reserve fund to meet annuity liabilities. Once an annuity provider is no longer viable, you may have the option of transferring your annuity to another provider.

Regulation and compliance

Annuity providers are required to comply with certain regulations and laws governing the operation of annuity providers and the use of annuity funds. The regulatory environment increases the safety of fixed annuities, especially as regulators also monitor annuity find management and distribution. Since this monitoring takes place at least annually, regulators quickly sanction annuity providers who place annuity funds at risk and intervention subsequently occurs.

Rate of return

A fixed annuity's rate of return must compensate for inflation risk and longevity risk for it to be truly safe. After all, inflation risk reduces the real value of money. If a fixed annuity-investment uses a declared interest rate that is on par or marginally higher than the inflation rate, then the real value or return from it rapidly diminishes in the accumulation phase. In the payout phase for a fixed annuity, the payouts will diminish in real value over time. Fixed annuities that offer low payout rates may not safeguard the annuity investor against all the risks associated with the diminishing real value of fixed annuity payments.

Annuity-provider strength

A fixed annuity can only be as safe as the annuity provider who carries it. The more financially stable/ viable an annuity provider is, the lower the chance of the fixed annuity failing. This is an important factor since some annuity providers have better fund managers or healthier reserve funds. Annuity providers that stretch their business model too much beyond their core business-model or are affiliated with a holding company that is unstable must be viewed with suspicion.

Fixed annuities, in the strictest financial terms, bear some risk, even if it is only inflation risk. However, fixed annuities are much safer than fixed annuities and are generally safer than other low-risk income options. You should bear in mind that not all fixed annuities are equally safe. Once you choose a fixed annuity with a reputable provider and an ample declared interest rate, you would be able to rest without worry.

Learn more about this author, Darrell Victor.
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