The Truth About Fixed Annuities

Scott Brooks, MBA, CFP®
5-7 mins

Who Fixed Annuities Are For

Fixed annuities are for conservative investors who want safety and guarantees. If you like to preserve your principle, consider a fixed annuity.

If you are sensitive to loss and don't want to lose any money, fixed annuities might be a good fit for your savings.

CD owners like fixed annuities because they are similar in many ways.

If your time horizon is more than 2 years, you should consider a fixed annuity. If it’s less than 2 years, consider a CD, savings account, or money market account.

Fixed annuities are simple and easy to understand. In 1998, while working for Bank United Securities in Plano, TX, a mentor of mine told me:

"Scott, I am going to teach you the FACTS about fixed annuities."

I want to share with you what he shared with me since it's still relevant today.

The Facts Of Fixed Annuities

F Flexible Contributions

A Avoid Probate

C Competitive Interest Rates

T Tax-Deferred

S Safety

Flexible contributions - Some fixed annuities allow for "flexible contributions." This means you can add money now and add money later. This is different from "single premium" annuities, which allow you to only add money once. Most MYGAs are “single premium” and most indexed annuities are “flexible premium.”

Avoid Probate - Bank CDs and other products can go through probate. In some states, probate can be time-consuming and expensive. Annuities pass by beneficiary designation, not probate. Your named beneficiary can access the funds quickly and easily. There is no need to hire an attorney or pay probate fees.

Competitive Interest Rates - Fixed annuities may credit higher rates than bank CDs. Sometimes, fixed annuities pay more. Other times, CDs pay more. It's essential to shop both if you want to maximize the highest returns. Fixed annuities offer competitive rates to bank CDs. Interest rates are often closer to long-term bonds than short-term money markets or CDs.

Tax-Deferred Growth - Fixed annuities grow tax-deferred. You don't have to pay income taxes on the interest while the money is growing inside the annuity. You only pay income taxes on the earnings when you withdraw money from your account. Your money grows faster than it would inside a CD because of the triple compounding of interest. This is because you earn interest on the money lost to taxes. This is especially helpful if you are in a higher tax bracket while the money is growing. Tax deferral also means that annuity earnings do not affect your Social Security benefits like CDs and bonds do.

Safety - Fixed annuities are some of the safest ways to save for retirement. Insurance companies do not loan out your money as banks do. Banks take $1 in deposits and make $10 in loans. It's when these loans go bad that banks get into trouble because of leverage.

Insurance companies don't do this with annuities. Insurance companies are required by law to set aside money “reserves” to pay policy owners.

You can own fixed annuities in retirement and non-retirement accounts (non-IRA, Roth, Traditional IRAs, etc.).

Fixed Annuities vs. MYGA (CD-Type) Annuities

There are two types of fixed annuities.

1. Traditional fixed annuities

The traditional fixed annuity locks in your rate for an initial period. Then the insurance company pays you a "renewal rate" for the rest of the contract.

For example: Let’s say you have a 5-year traditional fixed annuity with 3% interest locked in for 1 year. The company would then provide a "renewal rate" for years 2-5.

I remember sitting in my office at Bank United Securities in Plano, TX in 1999. In walks a very angry senior who was unhappy because the insurance company had dropped her rate. Her insurance company had dropped her rate from 6% to 2% when CDs were paying 6%.

This is why you should consider locking in a rate for the entire term of the contract! It's also why we only sell multiple-year guaranteed annuities and refuse to sell a traditional fixed annuity product.

Tip: If you decide to ignore our advice and purchase a traditional fixed annuity, choose a company with reliable renewal rates.

This is important because the company decides the rate after the initial guarantee period.

Another tip is to be cautious with fixed annuities that offer massive bonuses in the first year. When an insurance carrier provides a huge bonus upfront, they are likely to lower the rate later. As they say, there is no free lunch.

Or purchase a MYGA because you don't have to worry about renewal rates.

2. MYGA (Multiple-Year Guaranteed Annuity)

Life insurance companies designed MYGAs to compete directly with bank CDs. Many people refer to MYGAs as "CD-type annuities" because they are similar.

With most MYGAs, the rate is locked in for the entire term of the annuity. There are no rate surprises because you know what you will earn every year.

For example, let’s say you have a 5-year MYGA annuity that pays 3%. The annuity would credit 3% interest each year of the 5 years of the contract. There isn't a "renewal rate" because the rate is locked in for the entire term.

We love MYGAs because there are no surprises for consumers. You know the term, the rate, and the interest you will earn before you invest. There should be no surprises.

Fees - Fixed annuities do not have upfront sales charges. They also do not have maintenance fees. Many fixed annuities have no fees whatsoever.

Terms - Most fixed annuities lock in your money for 2-10 years. You may want to set up an annuity ladder to diversify the rates you are getting.

Not all insurance companies offer MYGAs. Some do, some don’t. If you plan on taking RMDs from your annuity, make sure the product can do so.

Fixed Annuity Ladder

An annuity ladder is investing your savings in annuities with different maturity dates.

This lets you invest in both shorter-term and longer-term annuities.

Benefits of a fixed annuity ladder include:

  • Lock in longer-term rates
  • Increase access to your funds
  • Limit interest rate risk

Building a fixed annuity ladder is easy to do.

1. Divide your investment into multiple fixed annuities with different maturities.

2. When each annuity matures, lock in your annuity with the longest term in your ladder. Keep the money with the same company or do a 1035 exchange to transfer the funds tax-free to another product.

$300,00 invested in a 5-year annuity ladder

$100,000 in a 3-year annuity

$100,000 in a 4-year annuity

$100,000 in a 5-year annuity

Free Withdraw Options

Most fixed annuities allow you to withdraw a portion of your money penalty-free.

Some fixed annuities do not allow withdrawals during the term. Fixed annuities that don't allow withdrawals might pay a higher interest rate, so you get a higher rate but lose access.

Withdraw options vary from product to product. Do your research. If you might need access to the money for ANY reason, do not buy a fixed annuity without withdrawal options.

The IRS also charges a 10% penalty for any earnings withdrawn before age 59 1/2.

Insurance Company A Withdraw Options

Year 1 - Interest-only without penalty

Year 2 - 5% of the account balance

Year 3 - 5% of the account balance

Year 4 - 5% of the account balance

Year 5 - 5% of the account balance

Surrender Charges

Surrender charges are a fee charged to withdrawals. They are usually assessed as a percentage of the withdrawal amount.

Insurance Company A has a 5-year fixed annuity

Year 1 - 9%

Year 2 - 8%

Year 3 - 7%

Year 4 - 6%

Year 5 - 5%

At maturity - 0%

If the fixed annuity is owned until maturity, there are no surrender charges. Withdrawal taken before maturity are accessed penalties if there are no free withdrawals available.

If you might need access to some of the money, make sure to purchase an annuity with withdrawal options.

Also, consider any other assets you own and consider buying a shorter-term maturity. The last thing you want to do is lock up money you might need long-term.

Annuity ladders are popular because they allow you to access your funds. This would be another strategy to consider

Market Value Adjustments

When you invest in an annuity, insurance companies are making longer-term investments.

If you pull your money out early, they could make or lose money, depending on what happens with interest rates.

A market value adjustment is basically an additional charge or credit for taking money out early from an annuity.

Market value adjustments only affect you if you withdraw funds early. If you own the contract to maturity, market value adjustments do not apply.

If you buy a fixed annuity and rates rise, the market value adjustment would be negative. If you buy a fixed annuity and rates fall, the market value adjustment would be positive.

As you know, interest rates are meager compared to years ago. In 1999, I was selling MYGA annuities with a 6% guaranteed return!

Because rates are low, it's likely market value adjustments in the future will be negative.

If you may need access to the funds before maturity, do not buy a product with a market value adjustment.

However, if you know you won’t need the money, you should not worry about the rates.

Fixed annuities with market value adjustments usually pay a higher interest rate because insurance companies are protected in case rates rise and investors take their money out early.

If you don’t need access to the funds, go get the higher return, and don’t worry.

When your contract matures and comes due, you will have 30 days to decide what to do. You can withdraw the funds, transfer the money to another annuity, or annuitize the contract for income. If you don’t do anything, the contract will automatically renew for the same term with the same company. Please consider the tax implications for withdrawals before age 59 1/2 and work with a qualified tax professional.

If you pass away before the end of the contract, your beneficiary can surrender the contract and take a lump sum payment. They also might be able to spread the payments over 5 years.

What to do When a Fixed Annuity Matures and Comes Due

When your contract matures, you have several options.

1. Take your money out. You can take out the balance in a one-time payment. Just let the insurance company know you want your money! Taxes would be due on all the earnings portion of the withdrawal. If you are less than age 59 1/2, you also get a 10% penalty on earnings. You can also have the insurance company send you the balance over a few years instead of a lump sum. Some do this to spread out their tax bill over a few years instead of all at once.

2. Keep your money with the company. Your insurance company should send you a letter when the maturity is near. They will offer you a rate to renew the annuity with them. You can decide to keep your money with them if you are happy with the rate they are offering at maturity.

Pay close attention to your maturity dates! Some annuities renew into the same term.

For example, you buy a 5-year fixed annuity. At the end of year 5, you might have 30 days to decide what to do. If you do nothing, the insurance company will renew your contract into another 5-year term.

3. Transfer your money to an annuity with another company. Why? To get a better rate! Always shop the market before making a decision. Make sure to do a 1035 tax-free transfer to keep the money growing tax-deferred. Section 1035 is part of the IRS tax code dealing with “tax-free” exchanges.

4. Convert your account balance into an immediate annuity. You can do this with your existing company or do a 1035 tax-free transfer at another company. An immediate annuity is a permanent decision, so make sure to properly plan for this.

Shopping for the Best Fixed Annuity Rate

3 reasons you absolutely must shop around to find the best rates:

1. Many banks and investment firms have an “approved list” of annuities they offer. The list is made of annuities they sell. Not all annuities are on these lists. I worked for two banks earlier in my career, and we only had access to a small number of products. Make sure to shop around. I recently surveyed one of the largest banks in the USA and they only had 4 fixed annuities available! This is horrible.

2. Many insurance agents won't show you all of the products. Even independent agents are only contracted with some of the companies on the market. Look for someone who is independent and is deadly serious about finding you the best deals. This is where we can help.

3. Many companies don’t want to show you fixed annuities at all. Why? The commissions are 3-4 times more on indexed or variable annuities.

If you speak with an insurance agent and they pressure you to purchase other products, find a new agent! We would love to help you and will NEVER steer you in another direction. If you are interested in index annuities, we can put you in touch with a partner of ours. Just know that if you deal with us directly, we only sell MYGA's, SPIA's, and DIA's.

Make sure to visit our fixed annuity rates database too. If you find an annuity that’s not in our database, please let us know, and we will add it.

Downsides of Fixed Annuities

1. Early withdrawal penalties of 10% for those under age 59 1/2. We believe the 10% penalty would apply to the interest but not the principal withdrawn before 59 ½ for non-qualified money.

2. High surrender charges if you need access to your money before the contract matures.

3. Market value adjustments may apply if you need the money before the contract matures.

4. The money is earning a safer type of return. It is not in the stock market with the potential for more upside growth.

5. Some fixed annuities automatically renew at the end of their term if you don’t do anything. Normally you have a 30-day period to decide what to do. Make sure to watch the maturity dates closely.

Who Buys Fixed Annuities?

1. CD buyers

2. Bond buyers

3. High-income earners who need safety, not risk

4. Conservative investors

5. Anyone who likes their principal to be 100% guaranteed

6. Anyone who does not like surprises

7. People who don’t want to lose any money

8. People who like guaranteed rates of return

9. Anyone who likes something easy to understand

10. People who don’t want to pay fees

Fixed Annuity Tips

1. Combine both CDs and fixed annuities in a ladder. You can make a 5-year ladder using bank CDs for 1 and 2 years. Then use fixed annuities for years 3, 4, and 5.

2. If you purchase a traditional fixed annuity, make sure the company has a reputation for high renewal rates. They decide what to pay you after the initial rate is up.

3. Shop the market before buying. This is important because many companies don’t have access to all the rates or don’t want to show you.

4. Fixed annuities avoid probate, so make sure to keep your beneficiaries up to date. If you get divorced and the ex if still on the contact, they get the money!

5. Use annuity ladders to diversify rates and get access to multiple carriers. Ladders also help in a rising rate environment.

6. Look for stable, highly rated companies. Consider their financial stability.

7. Don’t put too much money into annuities. Always keep some money liquid in case you need it.

8. Insurance agents’ commissions are lower on fixed annuities. They might not want to sell you a fixed annuity because the they make more money selling you other types.

9. Take advantage of our fixed annuity database. Do your research and then decide whom you want to do business with.

10. Let us help you. Our network of specialists is here to help

Fixed Annuity Commissions

Commissions range from 1-3% for fixed annuities. Ask your agent to disclose his commission.

Commissions are built into fixed annuities. Insurance agents are paid directly from the insurance companies. You don’t see it, but they should be willing to disclose it if you ask.

Our fixed annuity database reveals the commissions on most products. We feel it's important that you know.

The commissions on MYGAs, SPIA's, and DIA's are the lowest. Don’t be surprised if agents don’t get excited about showing them.

Variable and index annuities have the highest commissions. Expect agents to get super excited about showing these.