Fixed annuities have a number of features that make them a pretty attractive option for retirement savers, CD buyers, and retirees. In fact, in 2019, they were so popular that Americans purchased $125 billion worth of fixed annuities. No matter how you look at it, that's a ton of money. But there are 125 life insurance companies that sell fixed annuities in the US and hundreds of products. So how do you know what's right for you?
Independent insurance agents are absolute experts when it comes to confusing puzzles like these. Their job is to simplify the process by guiding you through all your options, weighing the good and the bad, and even seeing you through it all from start to signature. See? Easy, isn’t it?
Let's Start at the Beginning: What's an Annuity?
Annuities are policies issued by insurance companies. They pay a regular guaranteed income for life or for a period of years. You buy an annuity policy by making either a single payment or a series of payments. Annuities can be both fixed or variable and include:
- Deferred annuities accumulate money for a set period before the policy pays income.
- Immediate annuities start paying income right away.
- Qualified annuities are part of a pension plan or IRA. They are purchased with before-tax dollars.
- Non-qualified annuities are personally owned and paid for with after-tax dollars.
So What's a Fixed Annuity?
The reason fixed annuities are called fixed is a bit confusing. The value of fixed annuities is measured in dollars. When the value of the annuity rises or falls, it's because there are more or fewer dollars in the account. The value of variable annuities is represented by units. The value of each unit rises and falls with the investment it represents. The account value of a variable annuity changes based on the value of the units, not because there are more or fewer units.
That said, here's what matters. Fixed annuities guarantee principal. Once interest is paid, it is credited to the annuity account value and cannot be taken away or lost. When fixed annuities pay income, the amount of income is guaranteed. Annuities, though, are not backed by the FDIC like CDs. The guarantees are only as strong as the insurance company's financials.
What Are Multi-Year Guaranteed Annuities (MYGAs)?
MYGAs offer a rate of interest guaranteed for a set number of years. Typically, buyers can choose from a 1, 3, 5, 7 or 10-year rate. Interest is credited annually. MYGAs will typically offer rates that are higher than CDs. At the end of the guarantee period, the insurance company will reset the rate. The renewal rate has to equal or exceed the renewal guarantee in the MYGA policy.
What Are Fixed Index Annuities?
Fixed indexed annuities also guarantee principal. Instead of offering a rate of interest, the insurance company credits the account value based on the gains of a financial index, like the S&P 500. The gain cannot exceed the limit set by the insurance company, called a cap. If the index loses value, the account value remains the same. The advantage of a fixed indexed annuity is that the owner can benefit from the performance of the stock market without investment risk.
Fixed indexed annuities are measured by financial indexes, but should not be compared to them. They more closely resemble their MYGA fixed annuity cousins. The chart below shows hypothetical results of an indexed annuity with a 4.25% cap measured by the S&P 500, excluding dividends, in a 10-year "up market" and a 10-year "down market".
Hypothetical 10-Year Performance of a Fixed Indexed Annuity Based on S&P 500 and 4.25% Cap
What Are Immediate Fixed Annuities?
Immediate fixed annuities are also known as income annuities. That's because the insurance company begins to pay an income immediately after receiving a purchase payment, or premium. Immediate fixed annuities have several options for income:
Life only: A payment is guaranteed for the lifetime of the annuitant. No payments are made after the annuitant's death. Life only options will pay out a higher monthly or annual income than the other options. Joint and survivor life only is available for the longer of two lives, usually spouses.
Life & period certain: A payment is guaranteed for the lifetime of the annuitant. The payments are made for at least a "certain" number of years, regardless of when the annuitant dies. The certain year options are usually 10 and 20. Joint and survivor options are available for life and period certain.
Fixed period: Payments are made for a specified number of years, regardless of when the annuitant dies. The chart below is an example of life only payouts for a 65-year-old male.
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What Are the Pros of Fixed Annuities?
Tax deferral: Fixed annuities offer tax-deferred growth. Unlike a CD or savings account, interest is not taxable until it is distributed or withdrawn from the annuity.
Higher rates of interest: Fixed annuities usually pay higher rates of interest than CDs or savings accounts. The chart below shows an example of MYGA annuity rates available vs. CD rates.
Representative MYGA & CD Rates | January 2020
Guaranteed lifetime income. Fixed annuities can pay an income guaranteed to last for life. Of all the concerns impacting retirement for Americans today, running out of money, maintaining their lifestyle, and rising healthcare expenses continue to top the list, according to the American Institute of CPAs (AICPA) Personal Financial Planning Trends Survey.
Creditor protection. Some types of assets can be protected from lawsuit judgments or bankruptcy. For some people who may be more likely to be sued (think doctors, corporate executives, etc.), protecting their assets from creditors can be a very important reason to buy a fixed annuity.
Most states offer annuities some form of creditor protection. Some states protect all of the annuity proceeds from creditors, where others just protect the beneficiary's interest.
What Are the Cons of Fixed Annuities?
Tax penalties. There is a 10% tax penalty for any withdrawals before age 59-1/2.
Access to account values: Typically only 10% of the account value is available penalty-free during the surrender period. Deferred annuities used for collateral may trigger immediate tax consequences.
Surrender penalties: Most fixed annuities charge a fee if you cash in your contract or withdraw more than 10% of the cash value. Surrender penalties decline to 0 over a period of years, usually not more than 10. MYGA surrender periods should match the guarantee period.
Market value adjustments: The insurance company pays a fixed rate of return and absorbs any market risk. If you cash in your contract early, the insurance company loses money if interest rates are rising. The insurance company profits if interest rates are declining. The market value adjustment will be a cost or a bonus depending on interest rates.
What if the Insurance Company Goes Bankrupt?
Insurance companies that sell fixed annuities are regulated by each state's insurance department. The state insurance departments have financial standards for licensed companies. Each state has guarantee funds to reimburse policyholders if the insurance company fails. The limits for each state are different.
Financial ratings of insurance companies are available from A.M. Best, Fitch, Moody’s and Standard & Poor.
|Highest Ability to
|Medium Ability to
|Lowest Ability to
|A.M. Best||A++ to A-||B++ to B-||C++ to C-|
|Moody’s||Aaa to Aa||A to Baa||Ba to Caa|
|S&P||AAA to A||BBB to B||CCC to C|
|Fitch||AAA to AA-||A+ to BBB-||BB+ to CC|
Is a Fixed Annuity Right for You?
Fixed annuities are financial tools designed for retirement savings and lifetime income. Whether they are right for you depends on the job you want them to do.
Fixed annuities are conservative investments. There is no market risk to them, but they are guaranteed by the insurance company, not the FDIC. If you are looking for a tax-deferred alternative to CDs, or guaranteed lifetime income, a fixed annuity may be a good option.
Fixed annuities have limited access to account values during the surrender period. There are tax penalties for distributions before age 59-½. They are not a good choice if you need access to the money for emergencies or other purposes.
What's So Great about Independent Insurance Agents?
Nobody ever said fixed annuities are easy. Because the truth is, they aren’t. Now, they are a very beneficial and flexible financial tool, but they’re complex. Searching through the different options can be confusing, time-consuming, and frustrating. An independent insurance agent's role is to simplify the process.
They will make sure you get the right coverage that meets your unique needs and will break down all the jargon so that you understand exactly what you're getting.
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Advisor’s guide to annuities John Olsen
Fundamentals of Investments Wilson & Hopkins
NAIC Buyers guide to deferred annuities
NAIC Statistical Report Life And Annuity Companies 2018
IRS PUB 575
IRS PUB 410
Fitch Ratings Definitions
Moody’s Moody’s rating scale and definition
S&P Global Understanding Ratings
A.M. Best Why An A.M. Best Financial Rating Is Important
The American College of Trust and Estate Counsel State Survey of Asset Protection Techniques
Gainbridge Life 3,5 and 7 year MYGA rates as published 1-16-2020
Marcus Bank and Suncoast Credit Union 3 and 5 year CD rates available 1-16-2020