Fixed Annuity Examples
Fixed annuities have been offered in one form or another for generations. The underlying premise of the fixed annuity – safety of principle, stable, fixed rates of return, guaranteed income and tax deferred growth – has made it a mainstay of retirement planners for decades. Over the years, annuity providers have tweaked the various components and features of the fixed annuity in order to broaden its appeal. With the bulging number of baby boomer retirees looking at fixed annuities, it would be important to understand how the variety of fixed annuities compare to one another.
As the concept of fixed annuities began to catch on, annuity providers, in an effort to attract a wider array of investors, and in order to compete with alternative savings vehicles began to offer variations that provided additional guarantees, potentially higher returns and more flexible provisions for accumulating funds and distributing income. The menu of fixed annuities and fixed annuity hybrids has grown to where the original, traditional fixed annuity has become lost in translation.
Here we explore examples of the different types of fixed annuities as a guide for determining which is the most applicable in any given situation.
Traditional Fixed Annuity
Understanding the works of a traditional fixed annuity can provide the basis for understanding how each of its variations differs. Fixed annuities are a form of an insurance contract with a life insurance company where, in return for a payment of premiums, the insurer will guarantee a predetermined stream of income. Most fixed annuities credit the accumulating funds with a stated, or, current rate of interest for a specified period of time and guarantee a minimum rate for the life of the contract.
Using the minimum rate, the insurer can then project the accumulated values over a period of time. At the point in time when the owner would want to begin drawing income, usually at retirement, the insurer can project the income that will be generated by the annuity over a specified period of time or for the life of the owner. To do that, the insurer applies a different minimum interest rate as well as a life expectancy rate to determine the amount of monthly income.
During the accumulation phase, the owner may have access to the funds on a limited basis – usually up to 10% of the accumulated value. In the early stage of the contract, the insurer assesses a withdrawal charge, or surrender fee ranging from 7% to 10%. The fee is reduced by a point each year so that, after a period of 7 to 10 years, there is no more surrender fee.
During both of the accumulation phases, the insurer also offers a guarantee of principle which makes fixed annuities impervious to market volatility. All fixed annuities are considered to be life insurance contracts and, therefore, the interest credited on accumulating funds is not currently taxed. The IRS will penalize early withdrawals (10%) and the withdrawals of the interest portion are considered taxable income.
Originally, fixed annuities only offered a low minimum interest rate guarantee. They also offered a current rate, based on the yield of the insurer’s underlying investment portfolio. So, each year the rate would change to reflect current yields, but it could never fall below the minimum guarantee rate. While this ensured that the current yield would be somewhat competitive, savers were more attracted to alternative vehicles that offered longer, fixed guaranteed yields such as CDs. This became more important in a declining interest rate environment.
Life insurers then began to offer fixed rate guarantees for a longer, specified period of time, often with ranges of 1 to 10 years. Like a bank CD, the longer time period selected, the higher the fixed yield. A ten year term could yield as much 2 percentage points more than a one or two year term.
At the end of the guarantee term, the yield is adjusted to reflect the prevailing yields of the investment portfolio. Some of these fixed term annuities allow the owner the choice of another guarantee term or to accept the current yield each year. This type of fixed annuity can be advantageous during times of declining interest rates. If, however, interest rates begin to rise, there is a risk of lost opportunity to earn higher yields.
Don't Just Shop, Implement a Solid Retirement Strategy
Purchasing an annuity is a big decision. Online research is a good start, but prudent investors should discuss all their options and risks with an independent financial advisor. Request a free, no-obligation consultation today, along with a report of current rates on brand-name annuities.Speak with an advisor over the phone about annuities for FREE.
Market Value Adjusted Fixed Annuities
Market Value Adjusted (MVA) annuities are, in most ways, the same as a CD-type annuity with fixed rates guaranteed for a specific time. The primary difference is that, should the owner withdraw any funds prior to the time specified in the contract, the insurer will adjust the accumulated values based on interest rate movements. This acts in the same as a corporate or government bond where the value of the bond increases as interest rates decline and decreases when they rise.
The net effect is that the owner risks getting less than his principle amount back if there has been a serious decline in rates. With this mechanism in place, the insurer is able to credit a much more competitive interest rate than fixed annuities with principle guarantees.
Fixed-Index or Equity Index Annuities
Indexed annuities were introduced as kind of a hybrid of both fixed annuities that offer guarantees on interest and income and variable annuities that offer potentially higher rates of return on accumulation and income. The resulting product could be the best of both worlds for the investor with an appetite for higher returns but a low tolerance for market risk.
While the objective is to still provide safety of principle and stable returns, in a fixed-index annuity, the credited rate is tied to a stock market index. Because the insurer does not directly invest in equities and is only applying a rate from the index, these products are not registered as investment products. There is also a floor rate that guarantees a minimum return.
As the stock market rises, the rate credited reflects the gain in the index. For example, if the gain in the stock index is 10%, year over year, then the rate credited would approximate that rate of return. Most indexed annuities also include a cap on earnings which can limit their upside potential. For instance, if the annuity has a 15% cap and the market gain was 25%, the annuity would be credited with 15%.
The real benefit to the risk adverse investor is that the rate credited can never be below the minimum guarantee. So, if the market declined by 25%, the annuity owner would still receive the guaranteed rate. The income component of an index annuity also benefits from the potential of higher credited rates as well as minimum guarantees.
While all of these are examples of different types of fixed annuities, they all stem from most of the core elements of the traditional fixed annuity. It is important to keep in mind, however, that the more guarantees or potential for higher returns, the higher the costs. Guarantees and higher returns are more expensive to produce and so insurers need to recoup their costs through higher fees or extended charges. Before you choose, know your goals, risk tolerance and liquidity needs , and then know the total cost of ownership of the type of annuity you buy.
To find the best annuity products request a free, comprehensive quote comparision. Secure your retirement today, Get Started Now.