Why Choose Fixed Annuities for Retirement?

Retirement planning can feel overwhelming. With so many options available, it is hard to know which path to take. One option that stands out is the fixed annuity. This financial product offers a unique blend of security and growth potential, making it an attractive choice for many retirees.

This post, with certain concepts deliberately repeated for emphasis, will delve into the advantages of fixed annuities, their functioning, and the reasons they could be a suitable addition to your retirement portfolio.

What is a Fixed Annuity?

Annuities are generally classified into two types: fixed and variable. As the names imply, fixed annuities guarantee the security and stability of your principal, while variable annuities do not offer this guarantee but offer higher growth potential based on the performance of their variable "sub-accounts" that are similar to mutual funds. Moreover, fixed annuities often have significantly lower fees and expense ratios and do not include sales charges, unlike variable annuities, which are associated with high fees and sales charges.

Fixed annuities can be further divided into three primary types: "Fixed Rate" annuities, also known as MYGAs (Multi-Year Guarantee Annuities), which offer a fixed annual interest rate for a specified period; Fixed Index annuities, which offer a variable interest rate tied to the performance of a chosen underlying index such as the S&P 500, within certain limits; and Income annuities, which provide a set income amount over a selected period, with the option of lifetime income. Income annuities can start providing income immediately or deferred until a future date.

Key Features of Fixed Annuities

• Guaranteed, Predictable and Competitive Returns: A key attraction is the assured interest rate or income, often surpassing what other secure principal investments, such as bank CDs and savings accounts offer. This guarantees you receive a competitive rate with a high degree of safety including stable principal providing you clear insight into the growth or income your investment will generate over time.

• Longevity Risk - Most fixed annuities address "Longevity Risk" by providing a contractually guaranteed income stream for your whole life as a withdrawal option, even if your original principal runs out. This distinctive feature differentiates them from other investment options, as they offer a lifetime income guarantee, essential for income planning. Social Security and most pension plans are common examples of lifetime income streams that cannot be outlived.

• Sequence of Return Risk - Fixed annuities can assist in managing "Sequence of Returns Risk," which may arise when you start withdrawing from a variable return account after a significant decline in stocks, such as during the Finacial Crisis of 2008-2009. Avoiding these substantial decreases in income values during market downturns by securing guaranteed income beforehand can greatly impact the amount you can safely and reliably withdraw in retirement.

• Protection from Market Fluctuations: Fixed annuities are not influenced by market volatility, unlike individual stocks, equity mutual funds or variable annuities. This offers fixed annuity investors reassurance, especially during downturns in the stock or bond markets, and economic downturns.

• Tax-Deferred Growth: You do not pay taxes on the earnings accumulating in after-tax annuity policies until you withdraw the money. This allows your investment to grow faster through tax-deferred compounding while giving you options at maturity to control taxation on your gains.

• Innovative "Hybrid" Fixed Annuities with Long Term Care-Linked Benefits - Fixed Index annuities offering LTC benefits present a great alternative to traditional "use it or lose it" LTC policies, which have historically experienced significant premium hikes later in life, precisely when they are most needed. Due to the increasing premiums and the growing difficulty in passing health underwriting for traditional LTC policies, asset-based hybrid options have become increasingly popular over the past fifteen years now accounting for the majority of LTC coverage sales. Moreover, a select few after-tax fixed annuities with LTC benefits adhere to the "Pension Protection Act" (PPA) enacted in 2011, permitting the tax-free exchange of an old annuity or cash value life insurance policy balance that has appreciated into a PPA approved Fixed Index annuity with LTC benefits. By transferring an annuity or life insurance balance to a PPA-compliant Fixed Index annuity, you can avoid taxes on your original gains if the funds are used for LTC. This concept is thoroughly detailed in our FREE booklet entitled "Tax-Free Benefits for Long Term Care" by clicking the tab at the top of this page.

  
  

• Flexible Payout Options: Depending on your preferences, you have the option to receive payments on a monthly, quarterly, or annual basis. Some fixed index annuities offer enhanced income "riders" and "income bonuses" that increase income payouts. This feature comes with an annual fee, usually around 1% per year, which is deducted from your annual return.

Why Choose Fixed Annuities?

Selecting a fixed annuity as part of your asset allocation plan can be a wise financial decision for various reasons. Here are some of the most compelling benefits:

1. Stability and Predictability

In uncertain times, having a stable source of income or rate of return in your portfolio is crucial. Fixed Rate and income-oriented Fixed Index annuities provide predictable returns and income, allowing you to plan your budget with confidence.

For example, if you invest $100,000 in a 5-year Fixed Rate annuity paying a 5% interest rate and reinvest the income until you plan to begin withdrawal at maturity, you will know that your investment will grow to exactly $105,000 after one year, $110,250 in year 2, $115,762 in year 3, $121,550.62 in year 4 and $127,628.16 by the end of year 5 as seen in the chart below. This level of predictability in return and tax efficiency is hard to find in other investment options.

Year	Interest	Ending Amount
1	$5,000.00	$105,000.00
2	$5,250.00	$110,250.00
3	$5,512.50	$115,762.50
4	$5,788.13	$121,550.63
5	$6,077.53	$127,628.16

2. Safety of Principal

Your initial investment is protected, and your principal remains stable throughout the term of your annuity holding period. Unlike stocks, where you can lose money, fixed annuity issuers contractually guarantee that you will not lose your principal. This makes them an excellent choice for conservative investors who prioritize safety and security of their investment principal.

3. Tax Advantages

A key benefit of Fixed Rate and Fixed Index annuities is the tax-deferred growth they provide in after-tax accounts. You don't have to pay taxes on the interest earned in an after-tax annuity policy until you take out the funds. This enables your money to compound without immediate tax implications, accelerating the growth of your portfolio value over time while providing withdrawal options at maturity to manage taxes on your gains.

4. Customizable Options

Fixed Rate and Fixed Index annuities come with various options to suit your needs. You can choose the length of the contract, the interest rate, and the income payout schedule. This flexibility allows you to tailor the annuity to fit your retirement goals.

5. Ideal for Retirement Income

As you approach or begin retirement, ensuring a dependable income source is critical. Fixed annuities offer a consistent and predictable income flow, assisting you in managing your living expenses without the concern of market volatility.

6. Innovative "Hybrid" policies offer a viable alternative to traditional Long Term Care policies

Statistics consistently indicate that 7 out of 10 retirees aged 70 will need some form of Long Term Care (LTC) eventually, and since Medicare only covers the initial 100 days, it's crucial to include LTC planning in any financial plan. Neglecting to prepare for what could be the largest financial risk in retirement can significantly affect a retiree's portfolio and family. Hybrid Fixed Index annuities with LTC-linked benefits can be a great alternative to costly traditional LTC coverage for those who qualify. This important and popular LTC option is thoroughly discussed in our free booklet, which can be found in the tab at the top of this page labeled "Tax-Free Benefits for Long Term Care".

Fixed Rate Annuities - How Do They Work?

Understanding how Fixed Rate annuities work is crucial for making an informed decision. Here is a simple breakdown of the process:

1. Purchase: You buy a fixed annuity by making a lump sum payment to an insurance company.

   
   

2. Interest Accrual: with a Fixed Rate annuity, the insurance company invests your money and pays you a fixed interest rate for a specified period, usually between 3 to 10 years.

   
   

3. Payout Phase: At maturity, you can typically choose to receive your money in a lump sum or as regular payments.

   
   

4. Taxation: You are only required to pay taxes on your earnings in an after-tax account when you withdraw the funds, which enables your investment to grow and compound without immediate tax consequences. Upon maturity, you have the option to reinvest some or all of your annuity, which can help manage the taxation on your gains. Additionally, employing a strategy known as "laddering" where the maturities of your fixed annuities are staggered, can help control tax liabilities.

Comparing Fixed Annuities to Other Retirement Options

When planning for retirement, it is essential to compare fixed annuities with other investment options. Here are some common alternatives:

Stocks and Mutual Funds

• Volatility: Stocks can provide higher returns, but they come with significant risks. Market fluctuations can lead to losses, especially in retirement when you may not have time to recover.

  
  

• No Guaranteed Returns: Unlike fixed rate annuities, stocks do not guarantee returns. This uncertainty can be stressful for retirees.

  
  

Bonds

• Lower Returns: Bonds and bond funds typically offer more safety than stocks but yield lower returns. Fixed rate annuities frequently deliver higher interest rates compared to many bonds and bond funds, CDs, bank savings accounts and other investments regarded as low risk.

• Interest Rate Risk: When interest rates rise, the value of current bonds can decline. Most fixed annuities avoid this risk unless they are MYGA's that feature a prominently disclosed Market Value Adjustment (MVA) in exchange for a higher interest rate. In 2022, long-term bonds and bond funds fell about 30% from their highest to lowest points, surpassing the 26% drop in stocks during the same timeframe, offering no "safe haven" whatsoever.

  
  

Savings Accounts

• Low Interest Rates: Traditional savings accounts offer very low interest rates, often at a rate not close to keeping pace with inflation. Fixed annuities typically provide higher returns that also grow tax deferred in after-tax accounts and have historically outpaced inflation.

  
  

• Limited Growth: Savings accounts do not offer the same potential for growth as fixed rate annuities and are fully taxable outside of retirement accounts.

  
  

Real-Life Examples of Fixed Rate Annuities

To illustrate the benefits of fixed annuities, let’s look at a couple of real-life use scenarios.

Example 1: The Conservative Investor

At 60 years old, Jane aims to secure her retirement savings. She invests $200,000 in a fixed rate annuity offering a 6.5% interest rate over a period of 10 years.

In 10 years, her investment will have grown to $375,427.51. At that time, Jane can typically choose between receiving a monthly lifetime payment to spread out the taxes on her gains or opting for a one-time lump sum, providing her with reliable income and liquidity options during retirement.

Example 2: The Income-Seeking Retiree

Tom is 65 and plans to retire in the next five years. He eventually wants a steady income from his nest egg to cover his living expenses during retirement. He invests $150,000 in a fixed rate annuity with a 5.5% interest rate for 5 years.

After 5 years, Tom will have $196,044. He can then convert that sum to monthly payments for life, ensuring he has a consistent income stream throughout his retirement that he cannot outlive.

Common Misconceptions About Fixed Annuities

Despite their benefits, there are some misconceptions about fixed annuities. Let’s address a few of them:

1. They Are Too Complicated

Many people believe that fixed annuities are complex financial products. In reality, they are very straightforward. You invest a lump sum, earn a fixed interest or income rate, and receive payments or a lump-sum later.

2. They Are Only for Older Adults

While fixed annuities are popular among retirees, they can also be beneficial for younger individuals looking to secure their financial future. Starting early can lead to more significant tax-deferred growth and future income payouts.

3. They Have High Fees

Some investors may believe that fixed annuities come with high fees. However, although there are minimal internal costs for their management, which the issuer covers, fixed annuities have much lower internal fees and no sales charges compared to variable annuities and other investments that include sales charges and high annual expense ratios. Fixed Rate annuities are similar in structure to a CD and are straightforward; the specified interest rate is exactly what you will receive for the entire term and guaranteed by the issuer. As with any investment, it's important to read the fine print and understand the terms before investing.

In Conclusion: Fixed Annuities can serve an important function in a Diversified Retirement Portfolio

Fixed Rate and Fixed Index annuities with enhanced income options can play a vital role in a well-rounded retirement portfolio by ensuring financial security through guaranteed returns or income. They safeguard the principal investment thereby protecting retirees from market fluctuations. This stability offers them peace of mind, knowing that their savings are secure.

Fixed annuities offer a predictable income stream, essential for managing expenses during retirement. Unlike fluctuating investments, they provide consistent payouts, aiding in budgeting for long-term needs.

Moreover, fixed annuities can protect against inflation by incorporating cost-of-living adjustments, ensuring the preservation of income's purchasing power. They are flexible by providing a range of terms to align with particular financial objectives, whether through one-time payments or periodic distributions.

Finally, fixed annuities complement other retirement savings like 401(k)s and IRAs by adding security and reducing market risk in a portfolio, enhancing portfolio stability during financial market and economic downturns.

To sum up, fixed annuities can play an essential role in a comprehensive retirement portfolio by providing principal protection, reliable income, optional LTC-linked benefits, and increased financial security. Incorporating them can help ensure a stable and sustainable financial future.

Here are some suggestions for integrating fixed annuities into your retirement plan:

• Diversify Your Investments: Although fixed rate annuities provide security, it's crucial to maintain a variety of investments. Consider blending them with stocks, bonds, real estate, and other asset classes to form a balanced portfolio.

  
  

• Assess Your Risk Tolerance: Recognize your risk comfort level. If you favor a conservative strategy for a portion of your portfolio, fixed annuities could be suitable.

  
  

• Plan for the Future: Consider your long-term objectives. Fixed annuities can offer a dependable source of growth and income with principal and inflation protection, aiding in sustaining your lifestyle during retirement.

Making the Right Choice for Your Retirement

Selecting appropriate investment vehicles for your retirement portfolio is vital for your financial future. Fixed annuities provide a distinctive blend of principal security, growth potential, tax benefits and are available with LTC-linked benefits.

Take into account your financial objectives, risk tolerance, and the role fixed annuities have in your comprehensive retirement strategy before deciding if they're right for you.