Is a Fixed Rate Annuity Right for You?

Some hear the word annuity and automatically shun away.  Too expensive.  Too restrictive. The planners selling them are only wanting the higher commission.  There are times when annuties are sold that are inappropriate.  Before you consider making a purchase make sure you understand what you are getting.

There are two primary types of annuities – fixed and variable.  These can then be further divided by immediate and deferred.

Fixed annuities work very similar to a CD.  You are paid a fixed rate of interest, sometimes guaranteed for a year, three years or whatever period offerred.  Currently, many fixed rate annuitiesare paying a higher rate than what you can get for a CD  right now.    The interest rates are low like CDs but not as low because of the interest rate environment. 

Fixed rate annuities are not in the stock market so there is no volatility.  This is key.  If you are naturally adverse to the stock market or are in a position of needing a guaranteed rate of return, a deferred fixed rate annuity may be the right thing for you.

Generally there is a surrender period.  If you take the money out of the annuity early you will often have to pay a penalty.  You need to know when putting money into an annuity you should generally plan on leaving it there for seven years or more.  You may have access to 10% or 15% each year without being subject to the penalty.   You also have the additional advantage that you will not pay taxes on the earnings until the money is taken out of the annuity.  Fixed rate annuities may have an annual fee although this will often be waived at a certain investment level. 

A fixed rate annuity can be either immediate or deferred.  An immediate annuity means that you start to begin receiving payments right after making the investment.  Often to provide a guaranteed lifetime income, you elect to receive a payment from this annuity for life.  Many times the payment can be indexed for inflation.  So – the payment may be $100 the first year and with a 5% inflation feature it become $105 the second year then $110.25 the third year and so on.  As long as you keep living, the annuity keeps paying.  You can elect to have the annuity payout over the lifetime of a second individual also.

You can elect to receive a payment for a certain time-period.  Maybe you need money when forced into early retirement at age 55 so you elect a immediate 7 year fixed annuity to make payments to you until you turn 62 and can collect Social Security.  Maybe you want a 10 year payment until the mortgage is paid in full.  Generally you must elect any period of five years or greater. This is a great way to guarantee the money will be there and not have to worry about a drop in the market.

Consider putting enough into a guaranteed stream of income to insure that basic expenses will always be covered and be sure to put in the inflation feature.  This may allow you to be a little more aggressive with the balance of your portfolio since you know this is for the extras.

Make sure with your immediate annuity that there is the feature that you will get at least your principal back in case you die before the original invested amount has all been distributed.

A deferred annuity says that you do not wish to receive payments now.  The money will sit there, earning interest tax deferred until you are ready to begin disbursements.  You can at any time elect to just take a lump sum out, pay the tax on the earnings and spend the money as you wish.  Note, there may be a surrender period before you can take it out without a penalty.  Or you can turn it into an immediate annuity and start receiving payments for life.

Certainly annuities are not for everyone, but there are times when they can be very appropriate – times when you want that guarantee.