When it comes to fixed annuities there are some things that should be considered. We take a look at the deferred fixed annuity basics. There are a large number of annuity products available today. One of these popular products is the fixed annuity, which has proven to be a valuable tool in retirement planning. Fixed annuities come in two primary forms; those that have a deferred payout and those that have an immediate payout.
Immediate annuities seek to payout income upon inception, while deferred annuities defer payment until a later date. For the purposes of this article we will focus on the deferred fixed annuity that's so often utilized as a savings vehicle these days.
Fixed annuities are most commonly compared to certificates of deposit (CDs) by those investors seeking safety. And rightfully so, as they both are considered lower-risk investments, though they really are quite a bit different. The one-size-fits-all philosophy does not apply here.
Much like other financial products you must weigh the pros and cons in determining which may be more appropriate for your financial needs. Evaluating the following should help in determining whether a deferred fixed annuity is suitable for your unique needs.
Rate of Return
Both CDs and fixed annuities generally base their rates on current market conditions and time to maturity. Typically, the longer you wait to maturity, the higher the yield you'll receive. Fixed annuity rates have been traditionally higher than CD rates due to longer maturities and rate conditions.
Fixed rate annuities may have the edge in longer-term returns, but they are not short-term investments. The typical deferred fixed annuity ranges in periods from 3 to 10 years. If you have short-term investment objectives, a CD is probably more appropriate for your situation.
It's important that you understand the liquidity issues as they may relate to your CD or fixed annuity investing. CDs may provide for a shorter time horizon, but that doesn't mean they're liquid. When purchasing a CD you're obligated to that CD's time period, most commonly a year. If you withdraw any amount of your principal prematurely, you'll be subject to interest penalties. Also, remember that when your CD does come due, you'll have to deal with fluctuating rollover rates.
Fixed annuities also have restrictions, though they are more flexible, in that you can usually access a portion of your principal without penalty. They commonly provide penalty-free access of up to 10 percent of your purchase price annually, while some may make it cumulative up to a certain percent.
Accessing all of your funds early may result in a surrender charge. These surrender charges decline over the annuities term, ultimately going to zero.Fixed annuities also come with some age restrictions. Withdrawals made prior to age 59 1/2 are subject to a 10% tax penalty.
Tax deferred fixed annuities are exactly that—deferred from tax. This means that earnings within your annuity are not taxable until they're withdrawn. This comes with a number of advantages, such as tax control and more potential for growth.
Over time tax deferred growth outpaces taxable investments since earnings compound without current income taxation, year after year. It's important to note that investments like CDs are taxable each year, whether withdrawn or not. Depending on your tax bracket, this can have a detrimental affect on your CD returns. It's important to note that annuities are taxed as regular income, so withdrawals are best taken when income taxes are lower,such as retirement.
Both fixed annuities and CDs are considered to be safe investments. It's important to understand their differences, though. Most CDs are backed by the government through the Federal Deposit Insurance Corporation (FDIC). The current FDIC insurance limits are set at $250,000 per depositor. If your bank fails, you are protected up to that amount. Fixed annuities are guaranteed by the full faith and credit of the issuing insurance company, and are not limited or backed by the government.
This is why you should only consider those financial institutions rated "A" or better. You can determine the financial strength of these companies by reviewing the ratings at the prevalent rating agencies, such as Moody's or A.M. Best.
The higher rated insurance companies must meet stringent capital requirements to back up annuity and life insurance obligations. Always choose the higher rated company when comparing fixed annuity rates. Going with a lower rated annuity company for an insignificant increase in rate just isn't worth the extra risk.