What is a fixed annuity and how does it pay interest?

The word “fixed” describes the interest crediting, not everything about the product. A fixed annuity pays a declared rate the insurer guarantees in writing, which separates it from variable annuities, where your value rides the market, and indexed annuities, where crediting is tied to an index formula. Within fixed annuities, the key split is between contracts that guarantee a rate for the full term (the MYGA) and contracts that guarantee a rate for one year and may reset it afterward, subject to a contractual minimum. Which one you own changes what “guaranteed” means for you.

How the interest actually works

1. You deposit a premium, and the insurer declares a credited rate stated in your contract. In a MYGA, that rate is locked for the full guarantee period; in other fixed annuities, it may reset periodically but not below the contract’s guaranteed minimum.
2. Interest compounds inside the contract and is not taxed while it stays there. Per FINRA, earnings in an annuity grow tax-deferred and are taxed as ordinary income when withdrawn, not at capital gains rates.
3. Withdrawals of earnings before age 59 1/2 generally face an additional 10% federal tax penalty on top of ordinary income tax, per FINRA’s investor guidance.
4. During the surrender period, withdrawals above any penalty-free allowance in the contract incur surrender charges that typically decline year by year. Many contracts allow limited penalty-free withdrawals annually; the exact allowance is in the contract.
5. At the end of the term you can typically withdraw, renew, exchange to another annuity, or convert the balance into a stream of income payments.

What backs the guarantee

A fixed annuity is not a bank product and carries no FDIC insurance. The promise is only as strong as the insurance company making it, which is why the insurer’s financial strength ratings matter when comparing offers. Behind that stands a safety net: every state has a life and health insurance guaranty association that covers annuity obligations up to limits set by state law if an insurer fails. Coverage limits vary by state, so check your own state’s association through NOLHGA before assuming a specific amount is protected. Splitting large sums across insurers is one common way people stay within those limits, depending on their situation.

Where it fits, and where it does not

Fixed annuities appeal to savers who want a known rate, tax deferral, and no market risk on this slice of their money, often as a bridge between bank deposits and market investments in retirement planning. They fit poorly for money you may need during the surrender period, and tax deferral adds little inside an IRA that is already tax-deferred. Here’s what I tell clients: never put money in an annuity that you might need back before the surrender schedule ends, because the guarantee only works in your favor if you can leave it alone. Whether one belongs in your plan depends on your timeline, tax picture, and other income sources.