Today, a growing number of investors are looking for more stability in their returns. For older Americans, income reliability is essential. Worries about investments exposed to sudden market shifts that can wipe out a life savings are a huge concern. Consequently, there is increasing interest in fixed income investments that can pay a competitive rate of return while protecting principal. Savings accounts and CDs which are offered through banks offer safety (they are FDIC insured). However, bank interest rates are near an all time low and savings account and CD interest is fully taxable the year it is earned.

Fixed annuities have certain advantages over savings accounts and CDs. For example annuities typically pay higher levels of interest and the interest is tax deferred until it is withdrawn. In addition, annuities have major advantages over savings accounts and CDs when the owner passes away (see below). These distinctions and others can make a big difference for you and your estate.

An annuity is a contract between you and an insurance carrier. It is a long-term investment. You agree to give the carrier a certain amount of money (principal) for a certain amount of time. The carrier agrees to give you a certain interest over time. You can take the interest as a monthly income or you can let the interest grow without making a withdrawal. As long as the insurance company remains financially sound your principal will earn interest and it will not decline in value. Unlike banks, annuities are not FDIC insured but they do have protection through state Guaranty Funds which back other insurance products.

The following example shows why someone would use a Fixed Annuity that offers tax-deferred growth for long-term savings. Assume $100,000 earning 4% interest each year for 5 years and without money taken out of the account. At the end of the 5 years a CD that is taxable every year would be worth $115,254 assuming a 28% tax bracket. At the end of the same 5-year period a Fixed Annuity would have grown to $121,665. The tax deferred Fixed Annuity has accumulated $6,412 more than the CD. The longer the money is left in a tax deferred Fixed Annuity the more dramatic the difference in accumulation is. At the end of 10 years the taxable CD will have accumulated $132,834 while the tax deferred Fixed Annuity will have accumulated $148,024, a difference of $15,190. The benefit of tax deferral increases the longer the time frame and the higher the interest rate.

Fixed annuities also offer additional advantages such as riders that allow access to the money without any penalties in case of financial hardship, terminal illness and nursing home needs. Other riders ensure that if the owner of the Fixed Annuity passes away that this money will not incur penalties if accessed after their passing but prior to the annuities initial length of term. Another advantage of using a Fixed Annuity for long-term savings when compared to a CD is how the money is handled at the owners passing. The money in a CD will pass to the beneficiary after going through the probate process and this often creates delays and added expenses. Fixed Annuities pass to the beneficiary without going through probate as long as the beneficiary is an individual not an estate.

Without question, annuities have their detractors. Financial experts sometimes criticize annuities for early withdrawal penalties and fees. Naturally, investors who go into annuities ignoring the “rules” by which they operate can get penalized. Although most annuities allow some degree of early withdrawal (i.e. 10% per year), investors need to know that withdrawing more than the contract allows will result in a penalty. However, by learning the rules and using annuities to your strategic advantage, they can be an important part of your overall financial plan.

The Growth of Equity Indexed Annuities

Equity indexed annuities (aka Indexed Annuities) have become increasingly popular type of fixed annuity. Not to be confused with variable annuities which invest in stock mutual funds, indexed annuities use interest rates based on a formula tied to a stock index such as the S&P 500. Indexed annuities actually invest in fixed income instruments similar to other fixed annuities.

Indexed annuities give investors the chance to put money into a stock-like investment, getting some of the upside potential of the stock market but without the risk. If the market goes up, an indexed annuity will pay a return tied to the market. If the market goes down, the indexed annuity will typically pay “0” or no increase and the investor loses no principal. Today, there are some excellent indexed and traditional annuity opportunities for investors. However annuities can differ greatly by contract and carrier. It is imperative that investors use an independent broker that has access to multiple insurance carriers and can help suggest a contract that will work best for you.

As the population ages and more people seek future income security, annuities will likely play an ever increasing role. As you learn more about fixed income annuities it will hopefully give you both peace of mind and make you a better investor.

Is a Fixed Annuity Right for You?

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