Wednesday, February 24, 2021

Fixed Annuities 101: Buy Online, Get Higher Interest, Save for Retirement

A serious worry of many people facing retirement is the best way to assure themselves of a secure income once they stop working. Should they put their money in a low interest account in the bank or invest it in mutual funds?  For many people, part of their retirement financial planning could include putting part of their retirement savings in a fixed annuity where they could securely earn higher interest rates, but most people know very little about them. As a result, the guest post this week by Gainbridge will be an article on the basics of purchasing a fixed annuity, written by one of their experts. 

 As always, this blog encourages our readers to inform themselves thoroughly and consult with their financial advisors before making a final decision on any aspect of your retirement planning. The article below from Gainbridge will be a good way to start your self-education on annuities.



Fixed Annuities 101: A Tool to help Baby Boomers Save Safely


Many baby boomers are now just entering - or fast approaching - a well-deserved retirement. You’ve faithfully set aside funds for many years, enduring recessions, stock market sell-offs, and even a global pandemic along the way. But now that you’ve finally made it to this point, how can you help keep your savings so you can worry less about the swings of your portfolio and instead focus on enjoying your retirement? In this article, we’ll take a look at fixed annuities - a potential tool for your portfolio that can provide that peace of mind.

What is a fixed annuity?

When most of us hear “annuity,” we probably think of lifetime income, but a deferred fixed annuity (also known as a “fixed annuity,” a “multi-year guaranteed annuity,” or a “MYGA”)[1] can be a different product altogether - and a fairly simple one. An individual purchases a fixed annuity contract from an insurance company with an upfront lump sum, and those savings grow tax-deferred at a guaranteed fixed interest rate over a specified period (typically between 3-10 years).

It is similar in some respects to a common bank certificate of deposit (or CD), which also provides a guaranteed fixed interest rate over a specified period of time. But there are some key differences:

Interest rates. Fixed annuities typically offer interest rates that are often higher than CD interest rates. For example, as of this writing, the current Bankrate 5-year average CD rate is 0.34% APY, but 5-year fixed annuities offer fixed rates north of 2.50%   APY.[2] That difference can add up over time.

Contract Length. Fixed annuities have an accumulation period (or contract term) during which your money earns a guaranteed interest rate. These terms are often longer than those of CDs (which generally range from 1 month to 5 years).

Access. Fixed annuities commonly provide some access to your funds without penalty (whereas CDs usually do not provide penalty-free access).

Guarantees. Fixed annuities are backed by the issuing insurance company, while bank-issued CDs are backed by the FDIC and credit union-issued CDs are backed by the NCUA.[3]

Notably, a deferred fixed annuity also creates a tax-deferral benefit that helps more of your money grow for longer. Interest on a CD is subject to annual income tax, which CD owners must pay each year even if they leave those funds in the CD account to continue earning interest. Further, while some CD products allow interest to accrue throughout the product term, some issuers require accrued interest to be paid out to the owner at set intervals during the term, which reduces the benefit of compound interest. By contrast, a deferred fixed annuity always allows for continual compound interest through the contract term and defers any income tax obligation until the owner withdraws funds. Better still, the annuity owner can renew the contract at the end of each term (up to age 100) to maintain these benefits.
Is a Deferred Fixed Annuity Right for Me?

As you might expect, whether a deferred fixed annuity is appropriate for you depends on your personal and financial circumstances. The product is a low-risk fixed income product which offers guaranteed growth with less volatility and risk than stocks or variable annuities. That may be an attractive rationale for anyone – regardless of age – looking to eliminate some risk and to lock in gains earned on more volatile investments. For baby boomers aiming to protect their wealth as they approach or settle into retirement, this strategy may be even more appealing.

It’s important to remember that the IRS imposes a 10% tax penalty for annuity owners who withdraw funds prior to age 59 ½. The penalty is only applied to the interest earned – not to any principal invested – and can be completely avoided if the annuity owner renews a maturing deferred fixed annuity for a new annuity contract term, thus preserving the tax-deferral.

Other Key Considerations

The fixed interest rate for a fixed annuity contract is important, but it’s not everything to consider when choosing a deferred fixed annuity. Some other key factors include:

Liquidity. Are you able to withdraw funds from the annuity? Typically, early withdrawals from a deferred fixed annuity are subject to penalties called surrender charges during the contract term, but most deferred fixed annuities permit the owner to withdraw a portion of the contract value annually, in each year after the first year of the contract, without any surrender charges. This amount is known as the “free withdrawal amount.” Any funds withdrawn in excess of the free withdrawal amount may be subject to surrender charges and a market value adjustment, or MVA. Make sure you understand the surrender charge schedule, any MVA calculation, and the free withdrawal percentage before choosing a specific deferred fixed annuity, especially if there is a reasonable likelihood you may need access to some or all of the funds during the contract term.

Insurer Rating. Insurance companies are highly regulated to promote stability and ensure that they can meet their contractual obligations. Credit agencies such as A.M. Best and Standard & Poor’s (S&P) provide ratings for insurance companies as a general indicator of financial strength and stability.

Commissions. You may be wondering about whether there are any commissions paid to individuals selling a deferred fixed annuity and how that might affect the interest you can earn. While the insurance company issuing the annuity may pay a commission to a licensed selling agent or agency involved in the purchase process, the fixed interest rate quoted at purchase and the premium you invest is not reduced by any potential agent compensation. Additionally, if you purchase the product online, the insurer may have more flexibility to offer a higher guaranteed interest rate, all else being equal.

Death Benefit. If the owner passes away during the contract term, the annuity value is paid directly to the named beneficiaries without going through probate. If the sole primary beneficiary is the surviving spouse, the insurance company will generally permit the surviving spouse to continue the annuity contract as the owner.

A New Way to Purchase Annuities

A relatively recent trend is the ability to purchase annuities entirely online. If you are more of a do-it-yourself investor and don’t need the higher touch service provided by an agent or financial advisor, platforms such as Gainbridge have launched in recent years to allow for a fully digital application and seamless account opening process. These platforms have licensed representatives available to help with the online application and answer any questions, and the account can be open and funded within a few days.

Whether purchased online or via an agent or advisor, fixed annuities can help baby boomers protect some of their savings and earn a competitive, tax-deferred interest rate at the same time.

Save Smarter with Gainbridge Life

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NOTES:

1. There are variations of a deferred fixed annuity that allow the owner to make multiple investments over time rather than a single upfront investment. There are also variations where the fixed interest rate is only guaranteed for part of the contract term (e.g., the first year of the contract) and may be adjusted in subsequent years. However, for the purposes of this article, we will focus specifically on the multi-year guaranteed annuity, or MYGA, which has a guaranteed fixed rate for the entirety of the term and requires an upfront lump sum investment.

2.  APY = Annual Percentage Yield, which is the effective annual rate of return, after factoring in the effect of daily compounding interest.

3.  Bank deposits in the United States are typically protected from bank failure by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per insured bank, for any account ownership category (checking accounts, savings accounts, money market deposit accounts, and CDs). Credit union deposits in the United States are typically protected from credit union failure by the National Credit Union Administration (NCUA) up to $250,000 per depositor, per credit union, for any account ownership category (checking accounts, savings accounts, money market deposit accounts, and CDs).




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