FOR EDUCATIONAL PURPOSES ONLY
FIXED ANNUITY
What are the differences between a variable annuity and a fixed annuity?
If you choose a fixed annuity, the premiums you pay will be invested by the insurance company. The company board will declare a current rate of interest each quarter. If the rate declared is less than the guaranteed rate, the guaranteed rate will be paid. A variable annuity works more like a mutual fund. Your premiums will be invested in stock funds, bond funds, real estate funds or other kinds of cloned mutual funds that have no guaranteed rate of return. Instead, your return will vary based on the portfolio’s performance - hence the term "variable."
What is a tax-deferred fixed annuity?
All annuities sold by insurance companies are tax deferred. The term, "tax-deferred annuity" refers to a tax-favored savings program available under code section 403(b) to public school employees and the employees of nonprofit organizations. A fixed annuity contract is a contract between you and an insurance company in which the company, in exchange for a single or flexible premium, guarantees a fixed payment at a future date. Fixed annuities are "fixed" in two ways: (1) The amount you invest earns tax-deferred interest at a guaranteed rate (typically 1% to 3% under long-term U.S. government bonds) while your principal is guaranteed not to lose value. (2) When you withdraw or opt to annuitize (begin taking monthly income) you receive a guaranteed amount based on your age, sex, and selection of payment options. Be careful to ask about the many fees attached to every annuity contract. Most companies do not charge an initial commission, or load. Instead, they levy a substantial surrender charge of up to 10 percent of your principal if you want to cash out or transfer your annuity to another company within the first five or 10 years of the contract. However, some annuities permit a free withdrawal provision after the first year and for every year thereafter that surrender charges apply. This allows you to withdraw a certain percent (usually 10 percent) of the accumulated account value. Note that prior to age 59 1/2 these partial withdrawals would be subject to a penalty by the IRS unless you meet an exception. Most annuity sellers also charge annual maintenance fees of $25 to $50. Most annuity charges do not apply to so-called immediate annuities because once you have purchased the contract, it cannot be surrendered.
What features should I look for when shopping for a fixed-rate annuity?
A fixed-rate annuity is a contract between an investor and an insurance company. The investor agrees to make a lump-sum payment or series of contributions now in exchange for the insurer’s promise to provide the investor with a much larger lump sum or monthly payments several years from now-usually after the investor retires. "Ernst & Young’s Personal Financial Planning Guide" (John Wiley & Sons Inc., New York) suggests you look at these issues when evaluating fixed-rate annuities: 1) The company’s financial strength. You want to make sure the insurer is strong enough to be around when it’s your turn to start collecting payments instead of making them. 2) Surrender charges. Find out how much you will be charged if you prematurely end, or "surrender," the annuity contract. Also determine the conditions under which you can withdraw money without a surrender charge. 3) The company’s crediting history. This tells you whether the insurer has consistently paid reasonable rates to annuity holders over the years. More important, compare the rate to others. You should examine both the current rate history and the guaranteed rate for several companies. Find the three to five best rates, then choose the best contract and company among them, based on Ernst & Young’s method.
Are there any guarantees involved in a fixed annuity?
When an insurance company sells you a fixed annuity, it will make two basic guarantees. According to "The Investing Kit" (Dearborn Financial Publishing, Inc., Chicago), "The insurance company guarantees both the principal, excluding surrender charges, and interest based on the terms of the contract. The interest earned may vary over time, depending on the insurance company’s earnings and what rate the contract guarantees." Keep in mind however that there is no guarantee the insurance company will remain an ongoing concern. That is why it is best to deal only with those insurance companies of the highest rating.
What is the floor of a fixed annuity?
Fixed annuities guarantee you a minimum interest rate. What you are looking for is a company that always pays a competitive yield. Annuities guarantee a "floor" below which your interest rate won’t fall. The floor is low, usually 3% to 5%. Your risk is in selecting a company that won’t pay a competitive current rate. It may offer an initially high rate to lure you in, but then drop the rate once you are "locked in" to the contract. A typical scenario: you start out with a fat 11 percent yield the first year, a leaner 8 percent the second year, then down to 6.5 percent, and a huge surrender charge if you want out. The bigger the surrender charge, and the longer it lasts, the freer the company is to drop your rate.
If a fixed annuity carries a guaranteed rate of return, then why does the rate sometimes change?
With a fixed, group annuity, the premiums are invested in fixed-rate instruments such as bonds or mortgages. Your money earns a guaranteed fixed rate of return only for a certain period of time, usually for one to five years. After the guarantee period is over, the assets of the annuity are automatically rolled over for a new time period at a new rate. The new rate may be higher or lower than the initial rate paid on the annuity, depending on the overall direction of interest rates.