New Jersey Life and Health State Practice Exam

Lisa has recently bought a fixed annuity. Which of these is considered to be a disadvantage of owning this type of annuity?

1. High liquidity

2. Flexible payout options

3. Potential tax advantages

4. Decrease in purchasing power during inflation

The correct answer is: Decrease in purchasing power during inflation

Owning a fixed annuity comes with several benefits, but one significant disadvantage is the potential decrease in purchasing power during periods of inflation. A fixed annuity provides guaranteed payments that do not change over time, meaning the amount received will remain constant regardless of inflationary trends. As the costs of goods and services rise, the value of those fixed payments diminishes, leading to a loss in purchasing power for the annuitant. This is particularly evident in an inflationary economy where the fixed income does not keep pace with rising prices, resulting in a lower standard of living over time. The other aspects listed, such as high liquidity, flexible payout options, and potential tax advantages, represent favorable attributes rather than disadvantages. High liquidity generally refers to the ability to access funds easily, which is usually limited in fixed annuities. Flexible payout options imply that the annuity can cater to various needs and preferences, offering a positive feature for those seeking tailored payment structures. Lastly, potential tax advantages can provide significant benefits, as tax deferral may be available on the earnings of the annuity until withdrawals are made. These elements highlight the characteristics that contribute positively to the ownership experience of a fixed annuity, setting them apart from the disadvantage concerning purchasing power.