Fixed Annuities

 A Fixed Annuity is an interest bearing investment designed to generate income. They are funded by an initial deposit or premium. That premium will lock in a specified interest rate for a specified period of time (usually between 1-10 years). The reason why people choose a fixed annuity over a CD is that typically fixed annuities pay higher rates of interest then bank CD’s. So what’s the trade off? Why would anyone buy a CD instead of a fixed annuity? The two main differences between a fixed annuity and a CD are:

1. While it is true that both fixed annuities and CD’s have varying maturity lengths most individuals typically don’t buy annuities for fewer then at least three to five years. The amount of interest earned in a 1 year fixed annuity will not be substantially larger then the amount of interest earned in a 1 year CD. If for some unforeseen reason you needed to pull funds out before the stated maturity date the penalty that will be levied down by the annuity company will almost certainly be larger then the amount a bank will penalize you. Odd’s are if your thinking about purchasing a single year fixed annuity it’s because you don’t want your funds to be locked up for a long period of time. If you do need your funds out of a short term fixed annuity the early withdrawal penalty you’ll pay probably won’t make up for the extra interest earned from the annuity. For very short term investors, we believe that a CD is probably in your best interest.
2. The second main difference between CD’s and fixed annuities is who issue’s them. CD’s are issued by banks while annuities must be issued by an insurance company. So what’s the difference? As we all know our bank deposits are insured up to $250,000 by a government entity called the Federal Deposit Insurance Commission (FDIC). CD’s purchased from a bank are also FDIC insured, so they are guaranteed. A fixed annuity is issued by an insurance co. and is not backed by any government sponsored entity. This is not to say that a fixed annuity is a risky investment; in fact they are considered to be relativley safe. Because they do not come with an explicit guarantee it is important to purchase a fixed annuity through a reputable insurer with a strong financial rating. (Contact us for information on financial ratings and the insurance companies we recommend).

If you are considering a fixed annuity as a retirement investment then the next thing you’ll have to consider is what type of fixed annuity you want. This all comes down to one simple question. Do you need income now, or later?

Immediate VS. Deffered Fixed Annuities

If you are retired (or for any other reason) and need to secure an immediate income stream, then an immediate fixed annuity is an investment that you might want to consider. As the name implies you start to receive periodic checks after the first month of investment. Think of immediate fixed annuities as a retirement income booster. You have $200,000 in savings that you plan to use for retirement over the next 10 years. Rather than leaving it in the bank or a low-interest money market account or CD, you give it to the insurance company at a rate of 6% (for instance). The insurance company calculates $358,169 ($100,000 * 1.06 ^ 10) and divides it by 120 months to yield a monthly payment of $2,984. Had you not purchased the annuity, and just lived off the $200,000 for 10 years you’d have a monthly income of 1,666 or 1,318 less per month to spend.[*] Keep in mind that once purchased you lose access to the principal amount invested.

The opposite of an immediate fixed annuity is a deferred fixed annuity. A deferred fixed annuity as the name suggest does not start to payout right away but at some later date (5, 10, 20 years in the future). The major benefit that deferred annuities have over an immediate annuity and CD’s is tax deferral. Annuity income isn’t taxed until it’s withdrawn, and withdrawals are not made in the case of deferred annuities for as many as 10-20 years, would-be tax payments have time to earn money. Whereas interest on a CD would be taxed yearly, a deferred annuity balance earns interest on the money that would normally have to be paid to the IRS. The longer time horizon the more benefits an investor will see from this tax deferred growth. Payout’s from deferred annuities can be either in the form of a single lump sum, or periodic (monthly, semiannually) systematic withdrawals.

Just because it is called a deferred annuity does not mean that you can not pull any money out until the stated maturity date. Virtually all fixed deferred contracts feature an annual withdrawal provision, which stipulates the amount that can be withdrawn without incurring a penalty.

Immediate annuities and deferred annuities are designed with two different purposes in mind. If you need secure immediate income then consider an immediate annuity, while a deferred annuity is a much more appropriate investment for saving.