Integrity Now Insurance Brokers, Inc.

Fixed Annuity Pros and Cons: Top 12 Things You Need to Know

Fixed Annuities are an excellent way to protect your retirement as you near or enter into retirement.  There are many different ways to structure an annuity based on your individual needs.  

As your Annuity Agent we spend most of our time in the education process in order to help our clients understand how each type of Annuity works and which annuity option is right for them.  We do our best to remove the confusion of annuities and we do our best to keep them as simple as possible.  

Anytime you are considering moving your retirement savings from one account to another this can be a difficult task for people to overcome in their minds, as they have had their money locked up in a company 401K or Traditional IRA for many years. During this time they didn’t have to think much about these funds and as they enter retirement they want to protect these funds from a stock market correction.

Fixed annuities is a retirement solution that many people consider as these products can provide you with a guarantee income that can last both your lifetime and your spouse’s lifetime if it is set up this way. 

Obtaining an annuity is a major decision that we help our clients walk through.  It is important to understand the pros and cons of an annuity and we will do our best to show you both sides of the equation.  

Fixed Annuity Pros and Cons:

Fixed Annuities Pros

1) Guaranteed Returns for a Specified Period 

The fixed annuity is a very simple product similar to a CD that you can obtain through your local bank.  Depending on the fixed annuity term that you select (3 Years, 5 Years, 7 Years or 10 Years) these fixed annuities will pay you a set guaranteed amount of interest throughout the term of the annuity.  After the term is over they will usually continue to pay you interest but at a much lower amount.  It is important to either open a new annuity at the end of the term or transfer your money out so you can obtain a better interest rate.  Fixed annuities are perfect those individuals that are concerned about stock market risk as you approach retirement

2) Guaranteed Lifetime Income

As you enter retirement and lose your salary from your current employer, many retirees are concerned about having adequate income or running out of money as they deplete their retirement savings. 

If this is your greatest concern, this is one of the top reasons retirees obtain a fixed annuity. 

The process is very simple to set this up.  We compete an application, request for your retirement money to be transferred to the annuity company and the annuity company provides you with an agreed lifetime income based on your funds that will never run out even if the account balance goes to zero. 

With a fixed annuity your income doesn’t fluctuate due to stock markets corrections, or the rise or fall of interest rates.  The annuity contract you establish with the insurance company is guaranteed and a reliable source of consistent income.

3) Low Investment Minimums

Another great benefit of a Fixed Annuity is the ability to contribute a very small amount of your money.  Some investment advisors require a $500,000 minimum investment to manage your retirement savings. 

Many annuity companies allow you to establish a fixed annuity for as little as $1,000.  It is important to consider that the more money you have to invest the higher the interest rate they are willing to guarantee may be.  

We have found that if you have between $2,500 or $5,000 this will enable you to obtain the annuity companies who are offering the higher guaranteed interest rates.  

4) Tax Deferral

One of the key benefits of an annuity, no matter the annuity type you obtain are tax deferred products.  This includes the fixed annuity. 

Similar to your retirement accounts (Traditional IRA or 401K), the money you place into an annuity will grows on a tax free basis, until such time as you draw from the account to provide you with income. 

This does not mean that once the annuity term is over and you transfer these funds into a new annuity that you will have to pay taxes on those funds.  You are not responsible to pay taxes until you draw from it. 

For anyone who’s already contributed the maximum to their IRA and 401k for the year, annuities are a popular way to save additional funds for retirement on a tax deferred basis.

When you start pulling money out of an annuity, your tax burden will be based on an exclusion ratio.  This is the relationship between your account value when you begin withdrawals and your cost basis.

5) I Maxed out my 401K or IRA Contributions what options do I have

Some of our clients max out their 401K and/or Traditional IRA contributions for the year and are looking for an alternative way to save on their income taxes and grow more of their money on a tax deferred basis. 

Fixed annuities are another popular way to save additional funds for retirement on a tax deferred basis.

This is great news for those savvy investors who are working towards ensuring they do not run out of money in their retirement years.  

6) Flexible Payout Options

  • Timing.  Depending on the type of money you are using to setup your annuity (qualified funds (401K or IRA) or non-qualified funds (money from your checking or savings account)) you may have the option to draw income from an annuity now or at any point in the future.  For qualified funds you are required to start taking a distribution of these funds at age 72.  However if you setup a fixed annuity with non-qualified funds you are not obligated to any specific time period. 

For example, many people incorporate deferred annuity into their retirement strategies.  One reason retirees might consider setting up a deferred annuity is to help fund future medical bills or a Long Term Care facility.  As we age our medical expenses increase and our need for assistance may require full time help that our families may not be able to assist with. Long Term Care policies can be rather expensive so a fixed annuity could be a viable solution.  

  • Length.  You may have heard the term “period certain” in your research.  When you begin drawing income from a fixed annuity or what is called annuitization, you’ll be given several withdrawal options to select from.  Each option has pros and cons as depending on which option you go with can and will affect the amount of income you will receive.  Following are the most common chooses you may be given:
    • Straight life: Guaranteed income that will pay you each month for the rest of your life but not continue on to your spouse’s life.  This pays at a higher monthly rate.
    • Joint life: consistent guaranteed income payments each month for the rest of you AND your spouse’s lives.  This payment option will pay the two of you at a slightly lower monthly amount than than the Straight Life option.
    • Lump sum: As stated in the name this gives you the option to take all of your money at once.  If you go with this option you will be responsible for all taxes related to the lump sum amount.  
  • Period Guarantees. Most of our client do not pick the straight life payout option as they can be a risky proposition.  If you were to pass unexpectedly  immediately after annuitizing the funds, your family will have lost the entire amount you put into the fixed annuity. 

To guard against this possibility, insurance companies offer “period certain” payout scenarios.  By electing straight or joint life annuity payouts with period certain, your beneficiaries will receive your income payments if you die within a given time frame.  Usually this option is offered over a 10 or 20 year increments.

7) Inflation Protection

Annuities offer Inflation Protection as you can customize annuities to ensure that your monthly paycheck will keep pace with the cost of living adjustments.

This is critically important because inflation can have a devastating effect on your assets. If the annuity company offers this protection it is important to remember that the annuity company may change a fee for adding this protection so please ensure you evaluate your investment options showing with and without this rider fee.  These cost can either show up as an initial account setup fee or in lower payouts when you begin to collect on your annuity.

Having a clear understanding of how the product will perform with or without the inflation protection added will be an important question to answer on the front end prior to setting up your fixed annuity.

Fixed Annuity Cons

1) Limited Returns & Teaser Rates

Fixed annuities like your CD you obtain from your local bank will typically offer low returns as compared to returns you can obtain from a Fixed Indexed Annuity which participates in the market. 

For our clients who insist on having a 100% guaranteed interest rate the fixed annuity does offer better rates than a CD however they are still very low.  

As mentioned above it is important to open a new annuity after the term is complete or your annuity rate could be reduced to a much lower unfavorable interest rate.  

It is important to mention that fixed annuities are not a vehicle designed for high growth potential but rather protection of your investment and guarantees.

2) Fees, Commissions, and More Fees

All investments have built in fees that can cut into your return such as your 401K, IRA, Mutual Funds and annuities.  Of all of the different annuity contracts you can pick from, the fixed annuities are normally far less expensive than their more complicated cousins (fixed index annuity and variable annuities).  

Here are the fee’s you could encounter:

Surrender charge:  Most annuity contracts will incorporate some type of surrender charge.  This means that if you withdraw your money prior to the end of the agreed timeframe, the insurance company will assess a fee. This is a decreasing fee as you get closer to the end of the annuity term.

M&E charge:  There are also mortality & expense, and administration fees in annuities.  With fixed annuities, these charges are usually “baked in” to the interest rate you receive on your account balance.  If a policy offers you 4% returns and charges 0.25% in annual fees, your net returns will obviously be 3.75% per year.

Commissions:  Finally, annuities similar to buying auto insurance or home insurance from your local agent are normally sold as a commission products.  That means that an advisor or insurance representative recommending a product may well receive a commission if you choose to buy from them. 

It is important to mention that if you contribute $100,000 into an annuity the Insurance Agents commission does not decrease your investment amount.  Using an Insurance Broker who specializes in annuities, helps ensure you are obtain the best annuity available as we are not tied to a single company and we work for you the consumer. 

3) Loss of Flexibility

Fixed annuities have limited financial flexibility as they are offering fixed guarantees similar to a CD that you obtain from your local bank.  Fixed annuities have a set amount of time that they grow your money known as the accumulation period and at the end of the fixed annuity term a withdrawal period if you chose to annuitize verses obtaining a new annuity.  

Depending on which annuity you obtained, during the accumulation period, you may have some flexibility with the policy.  Some fixed annuity contracts allow you to withdraw up to 10% one time per year without incurring a penalty.  You may also  be able to surrender the policy and withdraw the balance in the event of a specified emergency.  Depending on what is important to you in accessing your money, can change our recommendation on which annuity company is best suited for you.  This can come at a lower interest rate, but greater availability of your funds.  

Once you annuitize your annuity which is knowns as your withdrawal period, you don’t have the same flexibility.  The insurance company will begin paying you income based on the income option you chose.  Once that decision is made it is set in stone.  It is important that you setup and pick the correct withdrawal period that is best for you and your specific situation.

4) Limited Inflation Protection

While fixed annuities do offer some inflation protection that are not full proof in those times when inflation is growing in huge leaps and bounds. 

It is important to consider all annuity and investment options before moving your money into a fixed annuity. 

One option that allows you to participate in market gains but not market losses is the Fixed Indexed Annuity.   These annuities can pay out murch higher interest rates year year.  However they may earn zero interest in those years when the stock market is falling. 

It is important to balance your decision when considering a fixed annuities that does not participate in the index but offers a lower fixed guarantee. 

The problem for retirees is that your cost of living will creep up slowly over time due to inflation.  Many retirees are now living into their 90’s and beyond.  That can equal 30 plus years past your retirement age, which can equal an income shortfall.  

As mentioned annuities come in all shapes and sizes.  And there are many products on the market today that will offer inflation protection, or participate in the stock market index.  Some of these products can help protect you from inflation.

5) Not All Annuities and Annuity Companies Are Created Equal

Fixed annuities can be a good option for some retirees.  It is important to discuss all available annuity options with your Insurance Agent to ensure the option you believe is best for you is actually your best option. 

Some annuities companies do not offer some of the best terms for clients while others have fewer restrictions which give our clients more flexible options. 

Your Insurance Agent who specializes in Annuities should know which companies take the best care of their clients and which have not been the best at customer service or charging higher than industry standard fees.  In addition by working with an Insurance Broker you can know they can move from company to company depending on where the rates fall from week to week.  This ensure you are getting the best payout available to you. 

It is very important that you understand the various features and terms that are applied to annuities.  As previously mentioned it may be worth going from a 3.00% guaranteed payout to 2.95% so you can have some additional flexibilities in the future.  

My Take on Fixed Annuity Pros and Cons

In looking over the pros and cons of the fixed annuity it is important to fully understand what you are getting prior to giving that company your money.  The same is true with any product you purchase.  We would encourage you to give us a call and talk with an annuity expert to go over your financial needs and let us show you what we believe is your best option based on your specific situation.  

Sometime we tell our clients that based on your financial information an annuity is not their best option.  Everyone’s situation is very different and we want to do what is best for you and your family.  

Give us a call so we can schedule a time to discuss your specific situation and we can then put together a plan that will meet your financial goals.

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