Types of Annuities

Traditional Annuities

The key word is "Fixed".

When you buy fixed deferred annuities contracts, you get two guarantees from the issuer:

• a fixed rate of return during the accumulation period
• many ways to receive retirement income, including payments guaranteed to continue for as long as you live

These guarantees are based upon the claims paying ability of the annuity companies. Both of these two are related. Your money in the annuity grows, tax-deferred, until you’re ready to make withdrawals. The income you will receive is determined by the earnings rate paid on your savings and the length of time your annuity has to grow. For many people, the certainty of a fixed rate of return is a chief attraction of fixed annuities.

How Interest Rates are Set
Annuity companies set the current rate of interest they will pay and revise it periodically. Rates may be adjusted monthly, annually or less frequently. Rates may increase or decrease, reflecting what’s happening in the economy at large and other factors. However it can never go below the guaranteed rate—typically 3% to 4%—that is determined at the time you bought the annuity.

As a rule, the interest rate is based on the return annuity companies earn on their own investment portfolio. The spread between what the companies expects to earn and what it commits itself to pay out, can help offset some of its expenses and provide some of its profits.

You can comparison shop for earning potential as well as for other factors, including high ratings and financial strength of the annuity company. Renewal interest rates tend to be lower than introductory or first year rates, making your decision more difficult. One solution is to compare older fixed annuities contracts as well as the new ones offered by the same companies.

Rating services rank annuity companies on their overall financial condition, which underlies their ability to meet their obligations. These reports are available in public libraries, on the Internet, from your financial advisor and from the insurance company if you request it.

The Risk of Guarantees
The trade-off to certainty, or the guaranteed return, is that the amount you get stays the same and does not increase with inflation the way that Social Security payments do. The major risk of any fixed income source is that your costs will increase over time, but the income you receive will not.

An income that was once adequate may leave you short of cash if inflation were to increase rapidly; and the longer you live and continue to collect your guaranteed return, the less your income is likely to stretch even if inflation increases only modestly.

An Escape Clause
Some fixed annuities have a bailout clause, sometimes known as an escape clause, that allows you to surrender your policy without penalty if the interest rate that’s being offered drops below a certain level, often one percentage point less than the previous rate, even if it’s above the guaranteed rate.

However, if an annuity's rate drops significantly, it usually means interest rates in general have dropped; and newly issued fixed annuities are likely to be paying at comparable rates to the one you’re giving up.

And if you transfer your money to a different type of investment or keep the cash, and you’re younger than 59½, you will probably have to pay a 10% premature withdrawal penalty on the amount of taxable earnings you surrender, plus whatever taxes are due on your earnings. If you withdraw only part of the accumulated contract value, the federal government considers that you take earnings first, leaving the principal in the contract. That means you could pay tax on the entire withdrawal amount.

Staged Interest Crediting
Some annuity companies credit different interest rates to the annuities' cash surrender value versus the annuitization value. This means that the interest rate you earn is based on whether you surrender the annuity for cash or annuitize the contract for some minimum stated period. Typically, the rate earned is significantly higher under the annuitization option.

But be aware: In order to actually receive the higher rate you must agree to the company's rules about how and when you can access your money after you have annuitized. When comparing products, it's important to know if the rate you're being quoted is applied to the cash surrender value or the annuitization value.

The Investments Companies Make
The money you invest to buy fixed annuities contracts goes into the carrier’s general account, along with premiums from other investors and other company revenues. Because annuity companies have such large sums to invest, they can diversify their holdings and potentially earn a better return on their investment for the same investment risk than you could as an individual with less money to spend.

A potential downside to buying fixed annuities may occur if the issuing company gets into financial difficulties, since its creditors would have a right to assets in the general account. However, these situations are uncommon, since the insurance industry is highly regulated and individual companies are rated regularly.

Caveat: Annuity companies touting returns that are much higher than the rates offered by the competition may be too good to be true. Sometimes, promises of stellar returns are a red flag that annuity money is going into riskier investments, like junk bonds. Before buying, ask to see the rate that the issuing company has paid over the past ten years and be sure to check the company’s ratings.

Added Protection
All states have state guaranty funds to protect contract owners against the insolvency of companies issuing insurance contracts, including annuities. There are also limits on benefits and coverage established by state law.

The financial consultants of Byrd Financial Group are Registered Representatives with
and securities offered through LPL Financial. Member FINRA/SIPC

The LPL Financial registered representatives associated with this site may discuss
and/or transact securities business with residents of all 50 states.

Copyright Byrd Financial Group© 2005-2008. All rights reserved. Variable Annuity & Fixed Annuity Rate Professionals.