What is Traditional Fixed Annuity?
A Traditional Fixed Annuity is a type of annuity contract that credits an interest rate that is declared one year at a time. Sometimes, during the first year, they will offer an upfront premium bonus or interest rate enhancement. After the first year, the issuing insurance company will re-set the interest rate on an annual basis. In all years, you are guaranteed to receive at least the contractually guaranteed minimum interest rate; you may earn interest at a higher rate than the minimum, but only the minimum rate is guaranteed.
Like all annuities, traditional fixed annuities are afforded special tax treatment. Income tax on annuities is deferred, which means you aren’t taxed on the interest your money earns until it is withdrawn. As your needs dictate, you can take partial withdrawals, completely cash out and surrender your annuity, or convert your deferred annuity into a stream of income payments, called Annuitization. You decide when to take income from your annuity and, therefore, when to pay the taxes. Gaining increased control over your taxable income is one of the key benefits of any annuity.
Traditional fixed annuities are sometimes called single-year guarantee fixed annuities. At Annuities Advisors, we frequently call them “trust me” annuities, because the insurance company essentially says, “give us your money and after the first year, trust us to be fair with you.” This can be okay, as long as the issuing insurance company has proven its trustworthiness over the years.
An often touted selling point with traditional fixed annuities is, because they have an annually adjusted base interest rate, when interest rates do rise, so will the crediting interest rate on your contract; whereas with a multi-year guarantee annuity, your interest rate is locked in and unchanged for an extended period of time, depriving you of the opportunity to take advantage of higher interest rates should they occur.
It’s an unfortunate fact, and it’s been our experience, that in a rising interest rate environment, the majority of traditional fixed annuity contracts do not realize increased crediting rates at nearly the pace at which most contract owners had hoped for. Some annuity issuers do a better job than others and have a track record of offering competitive renewal rates. Whereas, other issuers may have a record of only offering a renewal rate that is barely above the contractually guaranteed minimum.
The competitive annuity marketplace is one thing that helps keep insurance companies honest with their renewal rates. If the renewal rate offered on an existing traditional fixed annuity is too low, as compared to current interest rates available on new annuity products, policyholders will surrender their contracts and move their money to a new higher yielding alternate annuity. Most insurance companies do not want to see this happen, so if possible, they will attempt to offer a renewal rate that is sufficient to keep the money and retain the business. Keep in mind that charges may apply to withdrawals made prior to the end of the surrender period.
So what’s the bottom line? Depending on your individual needs, a traditional fixed annuity can be an appropriate purchase, if you do your homework and pick a well-designed product from a reputable company with an established history of crediting fair renewal interest rates. However, if you prefer a fixed rate annuity product with a little bit more certainty, you may want to consider a multi-year guarantee annuity instead.
If you have any questions or would like to discuss your options further, please give us a call. One of our licensed Annuity Specialists would be happy to patiently answer all of your questions without hype or any sales pressure.
Like all annuities, traditional fixed annuities are afforded special tax treatment. Income tax on annuities is deferred, which means you aren’t taxed on the interest your money earns until it is withdrawn. As your needs dictate, you can take partial withdrawals, completely cash out and surrender your annuity, or convert your deferred annuity into a stream of income payments, called Annuitization. You decide when to take income from your annuity and, therefore, when to pay the taxes. Gaining increased control over your taxable income is one of the key benefits of any annuity.
Traditional fixed annuities are sometimes called single-year guarantee fixed annuities. At Annuities Advisors, we frequently call them “trust me” annuities, because the insurance company essentially says, “give us your money and after the first year, trust us to be fair with you.” This can be okay, as long as the issuing insurance company has proven its trustworthiness over the years.
An often touted selling point with traditional fixed annuities is, because they have an annually adjusted base interest rate, when interest rates do rise, so will the crediting interest rate on your contract; whereas with a multi-year guarantee annuity, your interest rate is locked in and unchanged for an extended period of time, depriving you of the opportunity to take advantage of higher interest rates should they occur.
It’s an unfortunate fact, and it’s been our experience, that in a rising interest rate environment, the majority of traditional fixed annuity contracts do not realize increased crediting rates at nearly the pace at which most contract owners had hoped for. Some annuity issuers do a better job than others and have a track record of offering competitive renewal rates. Whereas, other issuers may have a record of only offering a renewal rate that is barely above the contractually guaranteed minimum.
The competitive annuity marketplace is one thing that helps keep insurance companies honest with their renewal rates. If the renewal rate offered on an existing traditional fixed annuity is too low, as compared to current interest rates available on new annuity products, policyholders will surrender their contracts and move their money to a new higher yielding alternate annuity. Most insurance companies do not want to see this happen, so if possible, they will attempt to offer a renewal rate that is sufficient to keep the money and retain the business. Keep in mind that charges may apply to withdrawals made prior to the end of the surrender period.
So what’s the bottom line? Depending on your individual needs, a traditional fixed annuity can be an appropriate purchase, if you do your homework and pick a well-designed product from a reputable company with an established history of crediting fair renewal interest rates. However, if you prefer a fixed rate annuity product with a little bit more certainty, you may want to consider a multi-year guarantee annuity instead.
If you have any questions or would like to discuss your options further, please give us a call. One of our licensed Annuity Specialists would be happy to patiently answer all of your questions without hype or any sales pressure.
Fixed Annuities Are better an Option than CDs
CERTIFICATES OF DEPOSIT are safe but stingy, paying only 2.5 percent or so even if you're willing to tie your money up for five years. But some financial advisors suggest an alternative for investors willing to lock money up: a short-term fixed annuity.
"Fixed annuities generally offer 35 percent higher rates than CD rates in all economic eras," says Samuel Rad, an instructor at UCLA and a planner at Affluencer Financial in Los Angeles.
Currently, investors can find five-year annuities paying about 3.25 percent a year, beating the five-year CDs substantially, says Eric Heckman, a planner in San Jose, California.
Annuities, as many investors know, are somewhat controversial insurance products generally meant for retirement. In exchange for an up-front premium, you get a steady income, fixed or based on investment returns. While there's no tax deduction on money put into an annuity, investment gains are tax deferred until they are withdrawn, with all payouts taxed as income as with an individual retirement account or 401(k).
Many investors are familiar with immediate annuities, which pay monthly income for life as soon as they are purchased. Deferred annuities also pay for life but don't start paying for a set number of years – and are more generous because of the delay. But unless you add expensive bells and whistles, money in an annuity is locked up for the long term and cannot be taken back as a lump sum. Payouts seem generous because each includes a bit of your original principal. If you die before payments equal your original purchase price, the difference is lost and not there for your heirs.
One option is the "term certain" annuity that pays for a given period and then stops. Another approach is a deferred annuity that starts payouts after five years.
"A five-year deferred annuity will pay a guaranteed rate of return for the duration of the contract," says Brian Saranovitz, co-founder of Your Retirement Advisor, an advice website. "The credited rate is typically higher than a CD of the same duration."
Because these products are designed for retirement, a five-year play is really best for people in their mid-50s or older.
Things to Consider
While a fixed annuity can remove market risk from your returns, there are other risks to consider when deciding if a fixed annuity is for you.
It may be difficult to get your money back once you pay the premium to the insurance company. Even if you only receive a few payments under a fixed annuity contract, the insurance company may not be obligated to continue payments to your spouse or refund your premiums to your estate.
If there are changes to your fixed annuity and you want to withdraw your money early, you could incur surrender charges that cut into your returns.
"Fixed annuities generally offer 35 percent higher rates than CD rates in all economic eras," says Samuel Rad, an instructor at UCLA and a planner at Affluencer Financial in Los Angeles.
Currently, investors can find five-year annuities paying about 3.25 percent a year, beating the five-year CDs substantially, says Eric Heckman, a planner in San Jose, California.
Annuities, as many investors know, are somewhat controversial insurance products generally meant for retirement. In exchange for an up-front premium, you get a steady income, fixed or based on investment returns. While there's no tax deduction on money put into an annuity, investment gains are tax deferred until they are withdrawn, with all payouts taxed as income as with an individual retirement account or 401(k).
Many investors are familiar with immediate annuities, which pay monthly income for life as soon as they are purchased. Deferred annuities also pay for life but don't start paying for a set number of years – and are more generous because of the delay. But unless you add expensive bells and whistles, money in an annuity is locked up for the long term and cannot be taken back as a lump sum. Payouts seem generous because each includes a bit of your original principal. If you die before payments equal your original purchase price, the difference is lost and not there for your heirs.
One option is the "term certain" annuity that pays for a given period and then stops. Another approach is a deferred annuity that starts payouts after five years.
"A five-year deferred annuity will pay a guaranteed rate of return for the duration of the contract," says Brian Saranovitz, co-founder of Your Retirement Advisor, an advice website. "The credited rate is typically higher than a CD of the same duration."
Because these products are designed for retirement, a five-year play is really best for people in their mid-50s or older.
Things to Consider
While a fixed annuity can remove market risk from your returns, there are other risks to consider when deciding if a fixed annuity is for you.
- An annuity's "guarantee" is only as strong as the insurance company that issues the annuity. There may be state guarantees in the event of an insurance company's failure, but annuities are not guaranteed by the FDIC, SIPC or any other federal agency if the insurance company that issues the contract fails.
- Payments in a fixed annuity typically do not have cost-of-living adjustments to keep pace with inflation, so the value of the money you receive in your payments may decline over time. Annuities with inflation protection can be purchased but the cost, in general, is significantly higher.
It may be difficult to get your money back once you pay the premium to the insurance company. Even if you only receive a few payments under a fixed annuity contract, the insurance company may not be obligated to continue payments to your spouse or refund your premiums to your estate.
If there are changes to your fixed annuity and you want to withdraw your money early, you could incur surrender charges that cut into your returns.
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