Difficulty: Medium

Average Score: 74%

Which of the following is a potential DISADVANTAGE of a fixed annuity?

Rationale

Annuitants could experience a decrease in the purchasing power of their payments over a period of years due to inflation.

Fixed annuities provide guaranteed payments over time, but these payments do not adjust for inflation, which can erode their purchasing power. As inflation rises, the real value of fixed payments diminishes, potentially leading to a financial disadvantage for annuitants in the long run.

A (Annuitants could experience a decrease in the purchasing power of their payments over a period of years due to inflation.) CORRECT

This choice accurately identifies a significant drawback of fixed annuities. While the payments are stable, they do not increase with inflation, leading to a decline in the real value of the income received, which may adversely affect the financial security of the annuitant over time.

B (There is no guaranteed specific benefit amount to the annuitant.) YOUR ANSWER

This statement is incorrect because fixed annuities actually provide a guaranteed specific benefit amount, which is one of their main features. The promise of a fixed payment stream is what makes them appealing to risk-averse individuals seeking predictable income.

C (The insured invests payments in variable securities and the return fluctuates with an uncertain economic environment.) YOUR ANSWER

This choice describes a feature of variable annuities, not fixed annuities. Fixed annuities involve a set return that does not depend on market fluctuations, thereby providing stability and predictability rather than variability in returns.

D (Payments continue only for a maximum of 2 years after the annuitant's death.) YOUR ANSWER

This option misrepresents the terms of fixed annuities. Many fixed annuities offer options for death benefits or continue payments for a specified period or until the total contributions have been paid out, which can extend beyond two years based on the specific contract terms.

Conclusion

The primary disadvantage of fixed annuities lies in their inability to protect against inflation, which can diminish the purchasing power of the income stream over time. While they do offer guaranteed payments, the lack of adjustment for inflation can lead to financial challenges for annuitants. Understanding these aspects is crucial for individuals considering fixed annuities as part of their retirement planning strategy.

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