During times of economic uncertainty, fixed annuities gain popularity. In fact, during the first quarter of 2009, the sale of fixed annuities increase 74%, according to a research association called LIMRA. Fixed annuities give people tax-deferred growth at fixed rates that are typically higher than certificate of deposits now. They also give the owners the ability to turn their fixed annuity into guaranteed income for life. Sounds too good to be true, right? A fixed annuity has a number of advantages – but it may cause you to miss opportunities that would result in earning more money.
Fixed annuities are often called “deferred annuity”. These are different from immediate annuities, in which you give a lump sum of money to an insurer and then begin receiving payments from the immediate annuity within a year’s time. Fixed, or deferred annuities operate more like a certificate of deposit in that you deposit your money under a teaser interest rate that can readjust annually based on the current economic and market conditions, but with a guaranteed minimum rate. People like this because they know their interest rate will not go below this guaranteed minimum rate, and that it could readjust for a higher rate in some cases.
Fixed annuities do not have a set time period that you must leave your money alone, however, you would pay a 7% surrender fee if you withdraw your money before five or seven years in most cases. This makes fixed annuities extremely difficult to back out of – which means if you find a higher interest rate somewhere else, you can’t just pull out your money and re-invest to benefit from the interest rates. Some fixed annuities are more flexible in that they allow you to withdraw up to 10% of the balance once per year without paying a fee.
As many experts predict, we will soon be entering an inflationary period. So locking in your money in a 4% fixed annuity could be financially devastating for you in terms of what you could have gained with other investments.
Where as money saved in a certificate of deposit is subject to taxable income, the money in fixed annuities will grow tax-deferred. Unfortunately, if you withdraw the money before you are 59 you will pay a 10% tax penalty, just as if it was a standard retirement fund. When you withdraw cash from a fixed annuity, you’ll also pay ordinary income tax on the interest you’ve earned.
Most annuities give you the option to “annuitize”, which is to turn the balance of your annuity into lifetime payments sometime after the first year. Many people with annuities choose not to do this though, because they use the annuity to grow their money tax-deferred.
If your goal is to find a safe growth for your money, you might consider putting your money in short or intermediate-term corporate and municipal bonds instead of annuities. They still offer interest rates that are higher than current CD rates, and have fewer restrictions than what fixed annuities offer. If the idea of the guaranteed income for life has tempted you toward a fixed annuity, you might want to look at immediate annuities which gives you pay outs within a year – the payment amounts will be greater than if you annuitize a deferred annuity later.