The Pros & Cons of Fixed Annuities
Solid, unexciting, stodgy and in fact downright boring but…are annuities safe? Well, back in 2007, it was hard to get anyone to admit that they actually put money into a fixed annuity! However, today it is a different story as many individuals lost substantial amounts of money during the Great Recession. Millions of people holding boring fixed annuities suddenly found themselves feeling proud about the fact that their fixed annuity did what a fixed annuity was supposed to do. It protected them from the crisis and saved all or at least part of their retirement plan.
Fixed annuities offer competitive interest rates, typically 1-3% higher than bank CDs and money markets. They were never designed to give returns that are available in the stock market, however; over the last ten years or so they have actually outperformed the market and may do so for the next decade or two.
The insurance provider and the contract available will determine the actual rate. Longer terms of five to ten years offer higher rates than shorter term annuities, though a one to five-year annuity can still potentially outperform bank CDs. In addition to earning higher interest rates, fixed annuities have even greater growth potential with tax-deferral accelerating their growth.
When comparing fixed annuities to CDs, many factors are clearly in favor of annuities. Moreover, CDs and securities don’t offer much in the way of additional retirement benefits. CDs have early withdrawal penalties as do fixed annuities and they are both considered safe and secure.
However if you keep your money liquid and lose the opportunity to make an extra 2% per year for ten years, you will actually pay a lost opportunity penalty of 31% by default. That extra 2% compounded will increase your asset value by 31%. So if you plan properly, the fixed index annuity for retirement has the potential to make a significant difference over fixed investments and cash equivalents, and, at times, it actually does beat the stock market! So even a 10% early surrender penalty on an annuity can be small compared to a potential 31% penalty by default for liquidity. In fact, annuities have many additional benefits: For more information about fixed index annuities.
Fixed Annuity Benefits
- Safety: Backed by highly rated state regulated insurers
- Tax Deferral: Tax-deferred growth
- Higher Return: Better interest rates typically than CDs
- Life Insurance: Death payout guarantee options
- Liquidity: Flexible withdrawal privileges
- Unlimited Contributions, unlike IRAs and 401(k)s
- Inheritance: Pass money directly to heirs by passing probate
- Lifetime Option: Income you can’t outlive (Annuitization or a Living Benefit Rider)
Fixed Annuity Characteristics
- Lump-sum or periodic contributions
- Invested in mostly high quality A-AAA bonds
- No risk to client. Insurance company assumes all risk
- Guaranteed interest
- Modest growth
- 3% to 6% interest crediting possible
- 1 to 15-year term
- Predictable, simple
- Guaranteed retirement income
- No annual fees
Investors that need their money prior to retirement may prefer a CD, money market or a securities-oriented investment to avoid the potential of a 10% IRS tax penalty imposed for taking money out of an annuity prior to the age of 59.5. For individuals at or near retirement, fixed annuities may be better choice. If you’re looking to have a larger retirement nest egg, fixed annuities may help you meet that goal better than securities, CDs or a money market account.
Question: How do you avoid being scammed the way Bernie Madoff MADE-OFF with his client’s money?
Answer: Never make a check out directly to a broker, insurance salesman or planner! Always make the check out to a third-party such as the institution that will receive the funds, never to an individual or their company.
Annuity Guys Video Transcript:
Dick: Okay, well let’s move on to fixed annuities. You want to take that for a minute and run with it?
Eric: Well, the most common question when I talk to somebody about a fixed annuity, they immediately think of a CD. They think it’s the same style as a CD, where you’re going to put a fixed dollar amount in and then you’re going to get that same interest rate for a five year period, six year period, three year period, whatever that period is, they’re going to get that same interest rate. Now there are annuities that exist in that form.
Eric: They’re MIGA’s which is another fancy, we’re getting in the…
Dick: Multi-year guaranteed annuity.
Eric: Yeah MIGA, so there’s your tip of the day, the MIGA is the CD-style, when you see those two words exchanged interchangeably.
Dick: Yeah, CD-style, MIGA
Eric: So that’s what most people think of when you hear fixed annuity. Well, a fixed annuity does not necessarily mean the same interest rate for every year. They can have bonuses. They can have minimum guarantees, but basically, what the fixed annuity would exemplify is that, saying you’re going to get a fixed return for a stated period.
Dick: Right and one of the ways that I think that I want to mention here, that it’s probably a strong point of the fixed annuity, is the safety of the fixed annuity, because when you’re looking at a fixed annuity, the idea of a fixed annuity is that the company actually takes all the risk. So the opposite Eric, of the variable annuity, where the client is taking on all the risk, so the downside though of the fixed annuity or the CD-style annuity that we’re talking about is, that it typically has a lower earnings potential, overall. Now that’s not true for all fixed annuities. We’re going to talk about some in a little bit here that have much higher earning potential, but just a standard fixed annuity, would be a little more limited on the interest that it pays out.
Eric: Correct, usually a little bit higher than a CD, but again, you’re talking it’s in that same secure, family kind of, now it doesn’t have the claims paying or the backing of…
Dick: Of the FDIC, right.
Eric: … which is one of the things that we want to spit out there. Make sure everybody understands that that’s not one of the pieces, that comes with an annuity, you want to make sure the insurance company is…
Dick: Is a good, solid company, very highly rated.
Eric: Exactly, because it’s the insurance company’s claims paying ability, which you want to make that decision on; if you’re going to make that choice.
Dick: Right and it should be noted that in the annuity realm, that it’s been considered extremely safe, fixed annuities have and they’ve got an excellent history of being there and paying out, with hardly any exceptions to that rule. So although we don’t want to compare it with FDIC, because that is the backing of the federal government, the history overall of the fixed annuity has just been excellent, so it is considered a very safe investment. You can always look at the third party ratings to make sure that you’re dealing with a really strong company in the beginning. You know one thing, Eric that I like about the third-party ratings is that you can watch these year by year, and you can see if they’re going in the wrong direction. You’ve got plenty of time to make a decision as a rule, because of the third party ratings. So it’s not something that we see those ratings like changing overnight. They might go a little bit one way or the other, but usually there’s a period of time. You start with a very high rated company you’ve got some time to watch that company if there’s ever an issue.
Eric: Right, right. Kind of pulling back to the fixed aspect of it, but yes the ratings are what you can kind of keep an eye on to keep yourself in line. It’s again, risk and reward. You’ve got a much more, safe box around a fixed annuity, but you’re accepting a lower return, and then it’s the 31 flavors again here, when we start talking fixed annuities, we have to decide what kind of sprinkles and what kind of pieces…
Dick: Right, what kind of things we want to add into that fixed annuity, which can make it a better overall retirement product.
Eric: Right, yeah. So I would say from a standpoint, fixed annuities are usually the base from which most other annuities now are considered, if this is where you start here with the base product of a fixed annuity, and then you’re going to add pieces on, most of the time to make it fit your situation.
Dick: And similarly, I think we would have to say going back to the slide before, and what we were talking about on variable annuities that variable annuities there are several pieces that are added into the variable annuity. What I’d like to have you understand at this point is that there’s really two primary types of annuity that you really want to get firmly in your mind. One is variable, where you take the risk, and the other would be the fixed annuity, where the company takes the risk, and then the risk on the principal, investment risk. So in fact, I think we have a slide up here we can throw up, that kind of re-emphasizes that. Once you actually understand that there are really two primary annuities, a fixed annuity and a variable annuity, now there are all kinds of variations of each. It helps you to know which annuity, maybe works out better for you.