Index Annuity Alternatives

An Overview

  • Fixed Annuities
  • Variable Annuities
  • CDs
  • Money Market
  • Bonds/Treasuries
  • Stock Market
  • S&P 500
  • 401(k) / IRA

There's no shortage of index annuity alternatives when it comes to retirement savings, and you'll want to examine all your options. If index annuities seem too unpredictable, fixed annuities, CDs, and money markets are a good alternative. If you prefer to manage your own portfolio and have higher risk tolerance, consider variable annuities, the S&P 500, or an IRA.

Remember that in practice, the best retirement plans are diversified across multiple investment types — in no way are these alternatives mutually-exclusive.

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Fixed Annuities

  • Guaranteed Rate
  • No loss of capital
  • Low liquidity; withdrawal fees
  • Tax-deferred
  • Ideal post-retirement

A fixed annuity is an interest-based contract issued and backed by an insurance company that locks in a yearly rate of return for a one-time lump-sum fee. Future rates are pre-determined at contract signing, typically ranging from 3-8% depending on the length of term. A 10% tax-penalty is levied against income withdrawals before the age of 59.5.

Generally, fixed annuities offer few benefits over their equity-index siblings. The most desirable feature of fixed annuities — the guaranteed premium — is also present in index annuities.

The one case in which a fixed annuity is preferable to an index annuity is if you require a predictable yearly return. With an index annuity, although your premium is guaranteed against loss, there's no way to know what the account balance will be next year. It might grow by as little as 1% or jump 15%. If your retirement plan can't handle deviations in rate of growth, fixed annuities are the way to go. Otherwise, you'll be better with a variable rate that yields higher returns in the long term.

Fixed annuities are most disadvantaged in generating income through debt-instruments, meaning lower yields. Unless you need absolute predictability, stick with an equity-based instrument. For more info, see the Fixed Annuity Guide.

Variable Annuities

  • IRA supplement
  • Unpredictable yield with potential loss of capital
  • Low liquidity; withdrawal fees
  • Tax-deferred
  • Suitable retirement instrument over long term

A variable annuity is a stock market portfolio contact managed by a broker for an insurance company. Sub-accounts of various risk levels are chosen by the contract owner and pay out interest depending on performance. Typical annuity terms and features apply: tax deferred growth, potential withdrawal charges, and the 10% tax penalty for withdrawal under the age of 59.5.

Variable annuities offer a slight advantage over index annuities on account of their potentially higher yields, but for a retirement savings plan index annuities arguably outweigh them with guarantees against losses. A variable annuity can be especially effective in the hands of seasoned investor who takes the time to study the markets and adjust his portfolio. If micro-managing your retirement sounds appealing and you have stock market experience, consider a variable annuity. Otherwise, most retirees would find comfort in an index annuity. For more info, consult the Variable Annuity Guide.

CDs

  • Similar to fixed annuities
  • 2-5% yield
  • Low liquidity; hefty surrender penalties
  • Not tax deferred
  • Secure retirement instrument

A certificate of deposit is a bank contract that locks in a fixed interest rate for a period of 1-5 years. At the end of the term, the initial deposit + interest is returned in one lump payout. Interest rates on CDs range from 2-5% and depend primarily on Federal rates. The bank earns money on a CD by re-investing your up-front deposit in higher-yielding debt instruments like government bonds and treasures.

CDs are safe, guaranteed, offer moderate growth with marginal liquidity, and are easy to set up; they're taxed at ordinary rates and feature no tax deferral benefits. Similar in many respects to fixed annuities, CDs are a preferred choice for younger investors, who would incur tax penalties when withdrawing from an annuity.

There should be no confusion in deciding between CDs and index annuities, as they has entirely different roles. CDs serve the purpose of sheltering your retirement plan from loss and counteract inflation. Index annuities are more aggressive instruments designed to actually grow your savings. Both vehicles have a place in your retirement plan.

Money Market

  • Ideal as a savings account
  • 2-4% yield
  • High liquidity with no fees
  • Best for money you plan to spend soon
  • Very secure, but too low-yield for a retirement account

A money market is a high interest savings account run by a bank or brokerage house. Money markets are secure, FDIC insured, completely liquid, and offer interest rates in the range of 2-4% —substantially higher than ordinary savings accounts. Money markets offer lower interest than CDs and annuities. What's more, that interest changes daily based on Federal rates.

Money market accounts have moderate minimum balance requirements ($1000+) and may limit withdrawals to several times a month. Even so, they are considered completely liquid, with no withdrawal limits or penalty fees. Money market accounts allow further investments to be made throughout their lifetime and never expire.

A money market account is hardly an alternative to index annuities. As a CD, a money market has its place along side more aggressive instruments, helping curtail annual inflation on funds that might be needed tomorrow.

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Bonds / Treasuries

  • Low, secure growth
  • 2-4% yield
  • Low liquidity; withdrawal penalties
  • Decent retirement savings instrument

Bonds and treasuries are government or corporate loan contracts, including things like high-quality mortgages and federal promissory notes. Bonds backed by stable institutions like the U.S. government are very secure but offer low interest rates; typically 2-4%. Treasures come with short, medium, or long terms, but generally have low liquidity.

Bonds are solid, if not high-yield, retirement savings instruments. As alternatives, they're closely in-line with CDs and somewhat resemble fixed annuities. As you approach retirement, it's wise to transfer more and more of your assets into bonds, as long as you feel your nest egg is enough to cover the necessities.

Stock Market

  • Very volatile, but excellent growth potential
  • 14% average yield (over very long term)
  • High liquidity; very low fees
  • Unsuitable for retirement savings

Direct equity investment is risky business, but it is an option. Stocks offer the highest growth potential of any investment on account of their tendency to lose investors' money. Over the very long term, stocks outperform all other investments, with an average yield of 14%+, but this figure averages hundreds of equities. There's always the chance that you'll stumble upon the next Microsoft or Google, but you must be mentally prepared to lose everything you invest.

The stock market is great for discretionary investment, and much less suitable for storing retirement funds — money that you'll NEED to survive. And although a lot of risk can be hedged with a balanced portfolio and tempered investment strategy, the market often behaves irrationally. Investors with accumulated wealth and nearing retirement should not gamble with their future. Over the long-term stocks looks like a sure bet, but an unfortunate set of circumstances can wipe out our saving when you need it most.

S&P 500

  • Moderately volatile
  • 10-12% average yield
  • High liquidity; very low fees
  • Suitable for aggressive investors

The Standard & Poor's 500 is a stock market index that tracks or averages the growth and dividends of 500 stable U.S. companies that represent a cross-section of entire U.S. equities market. Companies in the S&P 500 include 3M, Coca Cola, Exxon Mobile, and many other trusted brands. Historically the S&P 500 averages a 10-12% annual return. Indices such as these reflect the overall well-being of the U.S. economy.

Rather than purchasing a particular stock, investors can purchase and ETF (equity-traded fund) that tracks the S&P 500 or another index. Similarly, the S&P 500 can be invested into through mutual fund and 401(k) / IRA sub-accounts.

While direct index investment via ETF has the benefit of letting you pocket all the earning and pay very low fees, there is a great advantage to investing in an index annuity instead. For more real-world example of how an index annuity would have fared again a direct S&P 500 investment, see Index Annuity Performance.

401(k) / IRA

  • Starting point of any retirement plan
  • 7% average yield
  • Very low liquidity with penalties
  • Designed for pre-retirement investing

A 401(k) is a retirement account established through an employer. Employees typically despot a small portion of their monthly paycheck into the 401(k) over their entire career, eventually amassing a hefty retirement savings. Money in the 401(k) is invested in bonds and low-risk equities, depending on the chosen portfolio options.

A 401(k) or IRA is an excellent retirement savings vehicle, especially because employers often match the employee's contribution. They're also tax-deferred, like annuities. The 401(k) or IRA serves as the foundation of any retirement plan. If you're employed, strive to match your employer's matching limit. If you don't have access to a 401(k) through your employer, open an IRA and make steady monthly deposit.

Although a core component of any retirement plan, the 401(k) is often not enough. If you're looking for a comfortable retirement is a health reserve of discretionary income for travel and hobbies, an annuity can make up for the difference. It's important to note that your savings is not guaranteed against loss in a 401(k) or IRA as it would be in an index annuity.

Can index annuities really make the difference between a bare-bones and a dream retirement? Determine for yourself by Requesting Actual Rates.

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