2-Minute Money Manager: Should I Invest In a Fixed Annuity?

Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.

Today’s question is about fixed annuities; specifically, if they’re a good way to save for retirement.

Watch the following video, and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.

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For more information, check out “Ask Stacy: Should I Buy an Annuity for Retirement Income?” and “11 Pointers to Investing in Your 60s and Beyond.” You can also go to the search at the top of this page, put in the word “annuity” and find plenty of information on just about everything relating to this topic.

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Got a question of your own to ask? Scroll down past the transcript.

Don’t want to watch? Here’s what I said in the video

Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by MoneyTalksNews.com, serving up the best in personal finance news and advice since 1991.

Today’s question comes to us from Frederick:

I’ve seen fixed-rate annuities offered online for 8 percent guaranteed for life. What are your thoughts on these? It sounds really high, considering they’re annuities and the rate’s fixed.

Well, Frederick, let’s talk about fixed annuities. We’ll first define what they are, then go over some advantages and some disadvantages.

What’s a fixed annuity?

A fixed annuity is nothing more than a certificate of deposit (CD) from an insurance company, rather than a bank. As with a CD, you give them some money, they offer you an interest rate, and then they pay you back when it comes due.

There are also other kinds of annuities. A variable annuity is like a mutual fund. With an immediate annuity, you give the insurance company a lump sum, then it starts sending you monthly payments for a designated period.

Whether you invest in a fixed or variable annuity, you can turn it into a monthly income stream on some future date. This is called annuitization.

Advantages of annuities

Why would you go to an insurance company for a CD instead of a bank? Because insurance companies offer a couple of advantages that banks don’t.

One advantage is tax deferral. As long as you leave your money in the annuity, you don’t pay income tax on it. So, if you were earning 8 percent, you wouldn’t pay tax on that interest, as long as you leave it alone and let it compound.

Should you decide to close the account and take your money before you’re 59 ½, you’ll have to pay taxes and a 10 percent penalty, as you would with an IRA or other retirement account. But as long as you leave it until you’re over 59 ½, you won’t pay income taxes until you pull it out.

Another advantage of annuities is they bypass probate. As with retirement accounts and life insurance contracts, when you establish an account, you name a beneficiary. Should you die, your beneficiary gets the money without having to wait for the estate to go through probate court.

Disadvantages of annuities

As I mentioned above, a fixed annuity is like a CD from a bank. But here’s a major difference: Banks are insured by the Federal Deposit Insurance Corp., while insurance companies are not. So, you’ll have to be sure you’re dealing with a high-quality insurance company, since they’re the only ones guaranteeing your investment.

Fees can also be high. While you’ll earn the promised interest rate, there could be surrender penalties that last up to 10 years. Typically, they’ll start at something like 4 to 8 percent, then decline by 1 percent annually. So, you’ll have to read the fine print, see exactly what the deal is and be prepared to sit tight.

As for the rate you’ll earn, let’s go back to what Frederick said: “Eight percent guaranteed for life.”

That would be a screaming deal, Frederick, but I don’t believe it’s true.

I took a look at fixed annuity rates from decent insurance companies, and they’re closer to 4 percent than 8. And I’ve never heard of an insurance company guaranteeing any rate for life. So, I doubt you’re finding an 8 percent fixed-rate annuity. I’d look around a bit more, Frederick.

One more thing: Please don’t buy annuities from anyone who is a commissioned salesperson, which most are in this business. I’m not saying they’re all crooks; I’d just rather see you buy something like this from a non-commissioned salesperson.

I’d advise looking for annuities at places like Vanguard, where you’ll find decent deals, quality companies and non-commission-based help. Or, visit a fee-based financial planner.

Hope that answers your question, Frederick, and hope you’ll all meet me back here next time!

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About me

I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.

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