Finding The Best Fixed Annuity
Which Fixed Annuities Are Best?
Finding the best fixed annuity will mean different things to different investors. Understanding the different aspects within annuities is a crucial step in choosing an annuity that is best for you. Some may choose an annuity based on its interest rate, while others may put more of an emphasis on it’s benefits and features. Over the past decade, annuity features such as income riders have become more complex, but also very beneficial when used in the correct situation.
Factors to Consider :
- Strength and Financial Security of The Insurance Company
- Rate of Return vs Flexibility
- Current Interest Rate Environment
- Contract Length
Considering these factors will work towards maximizing returns while reducing risk. There are trade-offs for each factor: The longer the commitment, the less flexibility, the higher the rate. Look for contracts with the highest rate and the least flexibility you can tolerate.
Other benefits of fixed annuities are safety of principal, more liquidity than CDs and typically offer higher rate of return than bonds, CDs, or treasuries.
Fixed annuities sometimes offer higher interest rates than competing investments, such as CDs (certificates of deposit) because the insurance carrier puts your money in longer-term bonds, which typically offer better returns than short-term bonds. Whenever fixed annuities pay higher rates than other safe investments, they’re worth considering.
Strength Of The Insurance Company
The only serious risk posed by fixed annuities is if the insurance company backing the contract goes belly-up. In reality, most insurance companies hold solid, diversified portfolios that allow them to weather most economic storms.
Occasionally though, an insurance company can become insolvent. Even in these cases policy holders are still covered by Minimum State Guarantees, but it’s best to avoid this scenario altogether. How? Try to stick with A-rated or better insurance carriers. A lower rated company may offer more attractive rates, but the marginally better rates will not typically justify the risk. Go with a company you can trust and rely on.
Balancing Rate of Return and Contract Flexibility
A high-yield annuity is not necessarily the best annuity. Every investment has its trade-offs, and this is true of annuities. Be careful with what might seem like a free lunch. A high rate typically entails a stricter withdrawal schedule, a longer term, a larger premium, or a shortened guarantee period. For most shoppers the best annuities will have a healthy balance between all of the above.
Current Interest Rate Environment
Fixed annuity rates rise and fall constantly, mimicking the behavior of the general interest rate environment. As with CDs, you’re locking in a fixed rate for a set period of time, whether it be 6 months or 10 years. During that time, rates of return on other fixed-income vehicles may rise or fall while your rate is locked in. It’s therefore to your benefit to shop when rates are high or are suspected to drop.
That said, annuities are not to be regarded as stock-trades. You’re saving for retirement, not looking to make a quick, speculative profit. With this in mind, it’s more important to buy the annuity when it fits your retirement plan than to wait around and second-guess a perfect point in the cycle. Your strategy is to invest early and rely on compound interest and historical market averages to prevail, not forecast the market.
Buying Long Term
Higher rates correlate with longer term commitments and larger premium deposits. Insurance companies are eager to hold your money as long as possible so they can increase their return on investment. This being the case, they typically offer incentives for committing to longer contract terms. This can actually be to your benefit because retirement accounts are naturally long-term. As long as you’re comfortable and well-diversified, go for the longer term and get the better rate.
Double-check your annual penalty-free withdrawal limits to make sure it satisfies any potential need to take out funds for emergencies. If you want the highest possible rate, consider laying down a large premium. Insurers often offer better rates for large lump-sum investments. $5,000 might be the contract minimum, but it won’t lock in the best rate. You’re also better off purchasing a single $100,000 policy than four $25,000 policies. Consolidate small purchases to reduce paperwork, overhead, and fees.
Length Of The Guaranteed Rate
It might seem that a “4.5% fixed rate annuity for 10 years” means just that, but actually most fixed annuities only guarantee rates for part of the whole term. In this case, 4.5% might be guaranteed for only 3 years, potentially dropping at the start of year 4. When shopping around, be sure to maximize your guaranteed period. The trade-off is similar to a fixed vs. variable rate mortgage. A lower rate guaranteed for 10 years is preferable to a high teaser rate that expires one year down the line.
The good news is, the guaranteed period is golden — you’ll be earning that 4.5% regardless of market conditions. If the economy turns for the worse or interest rates dip, the insurance company could start losing money but you’ll still earn a profit. That’s why fixed annuities are great buys prior to economic downturns — if interest rates start to decline, it’s a good time to lock them in.