Cash in Hand
Fat Yields from Fixed Annuities
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
April 27, 2002
April 15 is tax day, so it's fitting to discuss a traditional tax-advantaged investment that is back in favor again: the fixed annuity. Yields are good, safety is high, and life insurance companies are competing vigorously.
There are several types of annuities, so let's establish exactly what we mean here. With a fixed annuity, you make a lump sum deposit or a series of contributions and earn a guaranteed ("fixed") rate of interest, determined by the period you select and competitive conditions.
Fixed annuities aren't tied to the stock market, as are variable annuities. Nor are these the income type of annuity in which you or a beneficiary gets a monthly check. Rather, these are CD-like plans; you can lock in rates for periods as short as one year (the most common) or several years, up to ten.
You can get some good deals. Life insurance companies pay higher rates than banks because insurers own higher-yielding, long-term bond and mortgage portfolios.
A long-term investment
Fixed annuities aren't for everyone. For tax-deferred retirement savings, IRAs and 401(k) contributions should come first. Then, if you have extra to put away for retirement or until age 59½, annuities are fine.
That said, I can't stress the long-term aspect enough. The IRS's 10% bite on withdrawals before age 59½, plus regular taxes on withdrawn earnings (rather than favored capital gain rates), means that these are wrong for money you would need in an emergency or for a targeted purpose like education.
Some insurance companies have become more understanding about early withdrawals and allow you to take some money out each year without imposing their own penalties. They may be even more lenient if you are diagnosed with cancer or suffer a heart attack. Even so, the tax disadvantages for early distributions are severe.
Take the plunge?
The biggest challenge for annuity buyers is making sense of the options and the confusing nomenclature. For example, Jackson National Life, a major annuity company with sound ratings and a record of paying good rates, offers 11 different fixed annuities.
As it happens, they differ in some cases only by the commission paid to the agent, which reduces the yield. If the same insurer has several alike-sounding products, and only the interest rate is different, take the higher rate. It's the same company, after all.
Competition among insurers has some offering bonus rates up front. Jackson National's BONUS MAX One, for example, offers a base 5.25% rate guaranteed for one year, plus an extra 3.75%, for 9%. Jackson has some other MAX annuities paying less. If you look out eight, nine or ten years, you'll see base rates around 7% -- maybe not enough to make such a commitment completely comfortable, but OK with part of your money.
Use the same laddering strategy with different maturities of fixed annuities as you would with a collection of CDs or a bond portfolio: some one-year money (so if rates are higher next year you can reinvest at a better rate) and some longer-term deposits to protect against falling rates.
To see what's available, consult some of the many good comparison charts online. These include annuityratewatch.com, annuity.com annuityinsider.com and more. You'll see what may seem like wide discrepancies among companies, but that's not unusual.
What matters is that the company is highly rated, the interest rates are above average, and you know what you're getting into: a long-term, fixed-rate, tax-deferred savings plan.