Fixed Annuities – What They are and how They Work

 

fixed annuitiesA fixed annuity is similar to a Certificate of Deposit. You get paid by an an insurance company a set-interest rate on your funds. Typically, there are some important differences between a CD and a fixed annuity.

Maturity or Term

CDs come in a variety of maturity dates ranging from 7 days to 10 years or more. It is common for a fixed annuity to have a “term” of 5 to 10 years, and they generally don’t come with terms of less than 3 years.

Getting out of a CD before its maturity date will cost you money, in neighborhood of 3-6 months of interest.

Annuities have what is known as a surrender period, which is generally shorter than the term of the annuity.

As discussed above you need to pay a special charge to the annuity issuer to take out money during the surrender period, so you want to avoid doing so whenever possible.  If you do have to take money out of your annuity during the surrender period, the penalty starts at around 7% of the withdrawal amount.

The amount of the surrender charge also depends on when you take the money out, as the surrender charge incrementally goes down to zero over time. Effectively, the surrender charge, while active, prevents major withdrawals from the annuity.

Like a CD at the end of the term of your annuity there may be an automatic renewal clause.  With this in mind you should make a decision on what you want to do with the money invested in your annuity before the term is over so you do not expose yourself to another long surrender period.

You can learn more about early withdrawal penalties here.

Interest Rate Comparison

Annuities on average pay slightly higher rates than comparable CDs.  With a CD, you are guaranteed a fixed rate of return ever year, which generally does not change through the maturity date of the CD.

With a fixed annuity, the interest rate is also guaranteed for a certain number of years. There are two types of fixed annuities: Multi-Year Interest Guarantee (MYIG) annuities and a traditional fixed annuities. With a MYIG annuity, the interest rate guarantee and the surrender period are the same. With a traditional fixed annuity, the interest rate guarantee is for a shorter time than the surrender period.

After the period in which the interest rate is guaranteed on a traditional fixed annuity, the new interest rate will be re-set according to market conditions (The minimum legal interest rate is 1.0%). To protect the annuity holder from a big interest rate drop, a few  fixed index annuities have a clause which allows the annuity holder to leave the annuity penalty fee if the interest rate drops by 1.0% or more.

Some fixed annuities also give a very high “teaser” rate during the fist year, and then dramatically lower their guaranteed rate.

Minimum Amounts

The minimum deposit for many fixed annuities is very high compared to CDs. Many fixed annuities have minimums of $100,000 or even $200,000.  You can however find fixed annuities with minimums as low as $5,000.  Some fixed annuities offer better rates when you open with more money.

**Annuities Do not have FDIC protection.

This lesson is part of our Free Guide to Investing in Annuities.  Continue to the next lesson here.
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