An Overview
The following features are common to most fixed annuities:
- Guaranteed Rate of Return
- Tax Deferral
- Secure Principle
- Option for Lifetime Income
- Bailout Provision
- Penalty-free Withdrawal Provisions
The Fixed Annuity Guarantee
The most appealing feature of fixed annuities — and why they comprise over 75% of all annuity sales — is their stable rate. While the markets are hit or miss, for retirees, a guaranteed 4-8% is very reassuring.
With a fixed annuity, not only do you get piece of mind, but you know exactly how much money you’ll have at the end of the term, which is ideal for retirement planning. If Jim invests $50,000 in a 10 year guaranteed fixed annuity rate. Assuming he doesn’t withdrawal prematurely, Jim can count on having $81,445 at the end of the term ($50,000 * 1.05 ^ 10). The only other investment vehicles to offer such certainty are CDs, bonds, and treasuries, but often at lower overall yields and without the benefit of tax-deferral.
Tax Deferral
All annuities are tax deferred, with no income-tax footprint until withdrawal. This can be a sizable advantage over analogous investment vehicles like CDs and bonds when considering long-term retirement investment. For detailed examples of tax-deferral in action, see fixed annuity performance, but to re-cap: reinvesting money that would otherwise be paid as taxes over a period of 10, 20, or 30 years adds up to a lot. Slowly but surely a long-term fixed annuity investment will outperform CDs, bonds, and treasuries because the latter’s annual tax payments diminish the effects of compound interest. To be fair, there are certain types of specialized CDs and securities, such as money market mutual funds, that feature tax-deferral, but none offer the same set of ancillary benefits for retirees as fixed annuities (like lifetime income).
Secure Principle
With the exception of CDs, money market accounts, and fixed annuities, no other investment guarantees zero potential loss of principle. But unlike CDs and money market accounts, fixed annuities typically offer higher rates and tax deferral. To be clear, this does not make annuity investment risk-free, but it does eliminate the most undesirable form of risk for retirees, who should be more concerned about the return of their money than a return on their money. With a fixed annuity, unless the insurance company completely collapses, the worst-case scenario is a lower-than expected return; never a loss. This protection is critical for any retirement savings strategy to succeed.
Option for Lifetime Income
Perhaps the most unique and useful feature available with annuities is the lifetime income option. This common provision allows annuity holders to seamlessly shift from retirement saving to guaranteed retirement living. A deferred fixed annuity used to accumulate wealth through periodic contributions during your 40’s and 50’s can be annuitized to pay out a guaranteed monthly income for the rest of your life. Based on the value of the balance and your actuarial life expectancy, the insurance company will issue a monthly income projection that it is guaranteed regardless of how long you actually live. The insurance company offsets the risk of you outliving your life expectancy by countless customers who won’t. And in return you gain insurance against outliving your retirement savings, which is becoming an increasing greater concern with rising life expectancy and healthcare advances. No other investment vehicle offers the flexibility and security of a lifetime optioned annuity.
Bailout Provision
Fixed annuities commonly come with limited periods of guarantee. The fixed rate might be promised for period less than the full contract term. The bailout provision is a protection against any wild fluctuations in rate once the guaranteed period elapses. The bailout provision ensures that if the insurance company drops your interest rate by more than 1% of the original, guaranteed rate, you have the option to cash-out penalty-free. At your choosing, the annuity can be liquidated and re-invested in a more competitive vehicle, which can be another annuity or something entirely different.
Example: Sally invests $100,000 in a fixed annuity with a guaranteed rate of 6% for 3 years, with a total term of 5 years. At the end of year three the guaranteed rate elapses. In this case let’s suppose it drops to 4.5% (a difference of over 1%). Now Sally is free to request a check from the insurance company without paying any single surrender charge. The bailout provision gives Sally the flexibility to find the highest rates on the market.