How Savers Can Earn More on Their Money, and Do It Safely

A piggy bank sits in front of a chalkboard with strong arms drawn behind it flexing their muscles. — (Image credit: Getty Images)

Interest rates on most safe investments, such as savings accounts, bank CDs, money market accounts and Treasury bonds, are super low these days. When you factor in even a tiny bit of inflation, you’re losing money in them, even before you pay income tax.

Annuities Just May Be the Broccoli of Retirement Planning

What are the best alternatives for people who want to get a higher guaranteed rate of interest?

It’s a big issue for people in their late 50s and older who don’t want to risk too much in the stock market and for retirees who rely on savings for income. Here are three good alternatives, all classified as fixed annuities, but different from one another.

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Fixed-rate annuities pay higher guaranteed rates

Also called a multi-year guaranteed annuity, a fixed-rate annuity acts a lot like a bank CD. Both guarantee a rate of interest for a set period. But there are some key differences.

One is that fixed-rate annuities pay much higher rates than comparable CDs today. As of early February 2021, you can earn up to 3.00% a year on a five-year fixed-rate annuity and up to 2.40% on a three-year contract, according to AnnuityAdvantage’s online rate database. Meanwhile, the top rate for a five-year CD is 1.00% and 0.85% for a three-year CD, according to Bankrate.

Annuity rates have held up remarkably well so far, but they are declining. If you’re interested in a fixed annuity, it could pay to take action sooner rather than later as you’ll probably get a better rate today than next month or beyond.

Another difference between annuities and savings accounts or Treasuries is that with an annuity, the interest you earn is tax-deferred until you withdraw it. You can either receive the interest annually and pay tax or let it compound in the annuity and thus defer taxes.

There’s one major caveat. If you withdraw money from an annuity of any type before age 59½, you’ll normally owe the IRS a 10% penalty on the interest earnings you’ve withdrawn, plus regular income tax on it. So, if you’re much younger than 59½, don’t buy an annuity unless you’re sure you won’t need to take out money before that age.

Another thing to keep in mind is that annuities of all types are guaranteed by the issuing insurance company. They are not FDIC insured like bank CDs and savings accounts. State annuity guaranty associations do provide a solid extra level of protection, however.

Fixed annuities are suitable for both nonqualified accounts (savings that would otherwise be taxable) and in qualified retirement plans, such as IRAs, Roth IRAs, and 401(k) and 403(b) plans.

Fixed indexed annuities offer potentially higher returns over the long term

Indexed annuities credit interest based on the growth of a market index, such as the S&P 500. The interest rate thus fluctuates annually. In up years, you’ll profit (keeping in mind that the size of your gains could be subject to caps and limits). In down years, you’ll lose nothing, but you won’t earn anything either.

How Annuities Are Taxed

So, for example, in year one you might earn 9%, 0% in year two, 4% in year three, and so on. If you’re OK with the risk of earning nothing some years, in the long run, you’ll likely earn more interest than you’d get with a fixed-rate annuity.

Indexed annuities are good for people who want to save for the long term and limit their risk without precluding growth. They’re not typically suited for people who need steady income right away to cover living expenses. Think of them as a distinct third class in an asset-allocation plan: fixed-income (CDs, bonds and other fixed annuities); equities (stocks and stock funds); and indexed annuities.

Because there are different crediting methodologies and caps, it takes some research to compare and determine which indexed annuity is best suited for you. Work with an annuity specialist who has the necessary resources and training to assist you in this process.

Income annuities produce much more guaranteed income

If you’re looking for the most guaranteed income, here’s an alternative you may not have thought of: an income annuity. Unlike fixed-rate or fixed indexed annuities, once purchased income annuities have no accumulation value, so they don’t pay a stated rate of interest. You pay a lump sum or a series of deposits to the insurer, which guarantees a stream of income.

You choose how long the payments last — for example, you could select 10 years. Most people, however, choose a lifetime annuity that will pay you (and optionally, your spouse) guaranteed monthly income no matter how long you live.

Income annuities produce more income because each income payment is made up of both taxable interest and tax-free return of principal (your own money coming back to you). It’s a bit like the flip side of a mortgage, where each payment you make includes principal and interest. A mortgage gets paid off eventually. However, lifetime income annuities keep on paying the same amount, even after the insurer has repaid your entire principal.

Lifetime income annuities serve as longevity insurance. They protect you against the risk of running out of money should you live into your 90s or beyond.

Income annuity payments come in 2 types: deferred or immediate – your choice

A deferred income annuity, which pays out starting on a future date that you choose, lets your money grow tax-deferred until you start receiving income. If you can afford to wait, it’s usually the better choice because the deferred income payments will be larger than immediate payments.

If you need substantial income soon, an immediate annuity can be a great solution. Typically, you’ll start receiving monthly payments within about a month of purchase. Many insurers will let you delay the start by up to a year if you like.

So, to sum things up, fixed-rate, indexed and income annuities all let you earn more on your money, safely, than bank CDs, Treasuries or savings accounts. They also offer tax deferral, another big plus. If you won’t need to tap your money before age 59½, all these different types of annuities are worth considering.

A free quote comparison service with interest rates from dozens of insurers is available at www.annuityadvantage.com or by calling 800-239-0356.

Myth Busters: Examining the Facts about Index Annuities

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Retirement-income expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed and immediate-income annuities. Interest rates from dozens of insurers are constantly updated on its website. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. More information is available from the Medford, Ore., based company at www.annuityadvantage.com or (800) 239-0356.