Problems With a Fixed Annuity
- Fixed annuities may be suitable for retirement income, but there are some drawbacks.Golfer in action image by Sean Wallace-Jones from Fotolia.com
Fixed annuities are tax-deferred savings accounts sold by insurance companies to retail investors. Fixed annuities are considered conservative investments with a fixed rate of return guaranteed for at least a one-year term, with adjusted rates renewing for another term. While fixed annuities are suitable investments for many investors, there are some problems to consider before investing. - Fixed annuities generally have a first-year bonus rate attached to the first year's interest return. Often the bonus is around 1 to 1½ percent, which means if current rates are 3 percent, you could get 4½ percent for the first year. This sounds great to many investors; however, when the anniversary date comes and the rate is adjusted without the bonus to current interest levels, investors may be disappointed. Investors should read the fine print to understand what the minimum guarantee is on renewals, because once you are locked in, you will lose a significant amount of earned interest for pulling out of the annuity.
- Fixed annuities range in duration from one year to 15 years. The term is called a surrender period, with a penalty assessed for taking distributions during this time. While the principal is protected in most fixed annuities, a surrender charge can quickly eat up earned interest in the early years when the penalties are highest.
For example, a seven-year annuity might have a surrender charge starting at 7 percent, declining 1 percent each anniversary date. If you are getting only 4½ percent in interest for the first year and decide to cancel the contract in the second, you will be assessed 6 percent on the distribution. For principal guaranteed annuities, the penalty is on the gross amount withdrawn but is limited to only interest earned. If the principal isn't guaranteed, penalties can erode earned interest and your principal investment. Keep in mind that annuities are designed for retirement and have tax penalties assessed for distributions prior to age 59½. - Even for conservative investors, fixed annuities may not meet income or growth needs. Investors who are in the accumulation phase of retirement savings may not be able to get enough growth to generate the needed income for retirement. Fixed annuities are not guaranteed to keep up with the rate of inflation either. Thus, an investor may find that initial budget considerations are no longer valid as the cost of living goes up in retirement.
