If you’re considering buying a fixed-rate annuity, which acts much like a tax-deferred version of a bank CD, should you wait until rates move higher?
Probably not.
First, it’s impossible to know when or if annuity rates will move up. The rate you get today may be as good as or better than the one you’ll get if you wait.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
Second, even if you do luck out and rates rise substantially, you’ll almost certainly come out behind. While you’re waiting, you’ll earn almost nothing in a money market fund or a bank savings account and only a bit more in a “high-yield” account. Depending on how long you wait, it may be nearly impossible to catch up later.
Despite recent declines, fixed-rate annuities still pay more than you might think. As of April 2021, you can earn up to 2.90% a year on a five-year fixed-rate annuity and up to 2.25% on a three-year contract, according to AnnuityAdvantage’s online annuity rate database. Compare that to the top rate for a five-year CD, at 1.15% and 0.95% for a three-year CD, according to Bankrate.
How delaying puts you behind
Let’s say you put $100,000 into a five-year annuity currently paying 2.90%. It will be worth $115,366 five years from now if you don't take withdrawals and let your interest compound.
Suppose you instead put your money in a money market account yielding 0.20% and wait for higher rates. After two years you’d be behind the annuity by $5,484. To catch up and achieve the same value at the end of five years, you’d need to find a three-year annuity paying 4.72%, which seems highly unlikely.
And this calculation doesn’t include the benefit of the annuity’s tax deferral.
Playing the interest-rate waiting game is a form of passive gambling, and it’s a bet you’re almost guaranteed to lose. It doesn’t make financial sense to avoid longer-term fixed annuities when interest earnings can be dramatically improved over cash equivalents.
If you’re uncomfortable about locking in today’s rates, consider a strategy of half now and half later. Allocate today half of the funds you’re considering for fixed-rate annuities. Set aside the remaining half in case rates increase soon.
Emotions too often drive financial decisions. But the numbers show it’s better to commit to a fixed-rate annuity today rather than wait for some potential higher future interest rate that may never come.
Fixed annuity pros and cons
Before you invest in an annuity, be aware of the pros and cons.
Benefits include guaranteed set rates, unlimited tax-deferral until you take money out, lower taxes on Social Security benefits for some retirees, and some liquidity. Most fixed-rate annuities let you withdraw interest or up to 10% of the value annually without penalty. Larger amounts are subject to a surrender charge if withdrawn before the surrender period is over.
Another drawback is that the IRS penalizes annuity withdrawals before age 59½. So, don’t use an annuity for any money you’ll need before 59½. You’ll also have to pay income taxes on any interest withdrawn unless the annuity is in a Roth IRA.
Unlike bank CDs, annuities aren’t insured by the FDIC. But they are considered quite safe. Fixed annuities are guaranteed by life insurance companies, which are strictly regulated by the states to ensure solvency. And fixed annuities are also protected by state guaranty associations up to certain limits.
A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.
-
I'm a Financial Pro: This Is How You Can Guide Your Heirs Through the Great Wealth TransferFocus on creating a clear estate plan, communicating your wishes early to avoid family conflict, leaving an ethical will with your values and wisdom and preparing them practically and emotionally.
-
To Reap the Full Benefits of Tax-Loss Harvesting, Consider This Investment Strategist's StepsTax-loss harvesting can offer more advantages for investors than tax relief. Over the long term, it can potentially help you maintain a robust portfolio and build wealth.
-
Social Security Wisdom From a Financial Adviser Receiving Benefits HimselfYou don't know what you don't know, and with Social Security, that can be a costly problem for retirees — one that can last a lifetime.
-
Take It From a Tax Expert: The True Measure of Your Retirement Readiness Isn't the Size of Your Nest EggA sizable nest egg is a good start, but your plan should include two to five years of basic expenses in conservative, liquid accounts as a buffer against market volatility, inflation and taxes.
-
New Opportunity Zone Rules Triple Tax Benefits for Rural Investments: Here's Your 2027 StrategyNew IRS guidance just reshaped the opportunity zone landscape for 2027. Here's what high-net-worth investors need to know about the enhanced rural benefits.
-
The OBBB Ushers in a New Era of Energy Investing: What You Need to Know About Tax Breaks and MoreThe new tax law has changed the energy investing landscape with expanded incentives and permanent tax benefits for oil and gas production.
-
Ten Ways Family Offices Can Build Resilience in a Volatile WorldFamily offices are shifting their global investment priorities and goals in the face of uncertainty, volatile markets and the influence of younger generations.
-
Should Your Brokerage Firm Be Your Bookie? A Financial Professional Weighs InSome brokerage firms are promoting 'event contracts,' which are essentially yes-or-no wagers, blurring the lines between investing and gambling.
