A fixed annuity is the insurance industry's version of a savings account. It helps you earn a modest rate of interest safely and allows you to postpone the payment of income taxes on your earnings.
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.
Annuity rates are the agreed-upon amount of money the insurance company / annuity providers pay out to annuitants. These rates are set by the specific insurance company used to purchase the annuity, and will vary from company to company (much like mortgage rates varying by lender.) A variety of factors go into determining annuity rates:
Generally speaking, fixed annuities and CDs are very similar in nature, with characteristics that mimic one another. However, the primary difference is that fixed annuities offer tax deferred growth, which sometimes can cause investors to prefer fixed annuities vs bank CDs.
Here we see the performance of a fixed annuity and a CD over a 20 year period. The assumed initial investment is $100,000, with a 25% tax bracket with both accounts earning a 4% interest rate. Because the growth on the annuity isn't taxed each year like the CD, it continues to 'work for you' by compounding interest. With an ending value of $175,351 for the CD, and $210,685 for the annuity, clearly tax-deferral pays off.
It is important to keep in mind that the growth of an annuity will incur taxes eventually. This happens when the funds are transferred out of the annuity and into a non tax-deferred investment vehicle, or when required minimum distributions begin. The benefit of tax-differed growth is that taxes you would otherwise be paying to the IRS each year continue to work for you and earn interest.
When comparing fixed annuities and CDs, the numbers clearly favor annuities. Moreover, CDs don't offer much in the way of redeeming features: they have withdrawal penalties just like fixed annuities and they're no more secure. In fact, annuities have better features:
Case in which it's advisable to purchase CDs would be if the purchaser is well below 60 years of age (because of the potential 10% IRS tax penalty). For investors over the age of 59.5, fixed annuities are typically the better choice.
The other conclusion to draw from the above example is the exponential significance of long-term annuity investment. If you're looking to generate a large retirement savings, fixed annuities can help you meet that goal better than CDs or a money market account. The key to success is to start early and be persistent.
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