Which ‘fixed’ annuity can fix your retirement?
Lifetime income guarantees and principal protection have always been the main value propositions that fixed annuities can provide. Indexed annuities with attached income riders currently dominate most fixed-annuity sales, but fixed-rate annuities might be a better alternative if you actually compare both products.
Fixed-index annuities (FIAs) are the hot product of the day in the annuity world, and are too often overhyped and over-promised during the selling process. Upfront bonuses along with high-percentage income riders make the strategy seem irresistible for people who want to buy the dream. The false premise of full upside market growth with downside protection in combination with income rider guarantees and high agent commissions is the fuel that drives too many inappropriate indexed- annuity sales.
Fixed-rate annuities (MYGAs—Multi-Year Guarantee Annuities) function similarly to a certificate of deposit and provide a guaranteed rate for a specific period. Most MYGAs can be turned into an immediate annuity (SPIA) by annuitizing the product, or by transferring the MYGA value to the highest-paying SPIA to maximize lifetime income. MYGAs are boring when compared with FIAs, but boring might be better.
For the record, I use both MYGAs and FIAs in my customized annuity recommendations. However, I only look at the contractual guarantees of both. In other words, my clients make their decision based on the worst-case scenario. Let’s take a look at some key aspects of both products, what contractually sets them apart, and my overall Stanalysis and comparison.
Return on investment
Fixed Rate: MYGAs provide a contractually guaranteed annual yield over a specific period. The shortest duration available right now is a 3-year guaranteed rate, and a 10-year lock in is typically the longest. I provide a live feed on my website that lists the top MYGAs in the country and allows you to look without having to sign up or talk to anyone.
Fixed Index: With most FIAs, options on a specific index like the S&P 500 have gains (if any) locked in on the contract anniversary date. The worst you can do is a zero return, and any locked-in gains are very limited by contractual caps or spreads. FIAs were designed to compete with CD returns, and that’s what they historically have done…and will do.
Stanalysis: Even though indexed annuities have the potential to outperform a fixed-rate annuity, it might make more sense to have the guaranteed annual return of the MYGA while keeping the policy surrender charge duration as short as possible.
Lifetime income options
Fixed Rate: Most MYGAs allow you to annuitize the contract to create a guaranteed stream of payments. You can also transfer the MYGA value to an immediate annuity to create a lifetime income stream. This makes sense when the MYGA company’s annuitization guarantee is not as high as another carrier that the funds could be transferred to.
Fixed Index: FIAs are typically sold with an income rider, which is an attached benefit that grows at an annual percentage and can only be used for future income. If an income rider is not attached, the accumulation amount can be annuitized to create a guaranteed stream of payments. I generally use FIAs as nothing more than delivery systems for the income-rider guarantees.
Stanalysis: Income riders attached to FIAs provide an income stream that is taxed at ordinary income levels. MYGAs can be turned into or transferred to an immediate annuity, and that annuitized income stream provides an exclusion ratio that an FIA with a rider doesn’t offer. The exclusion ratio provides a portion of your income that is not taxed (non-IRA account), and the process of annuitization traditionally provides a higher actuarial payout than an income rider attached to an FIA. In addition, if rates are higher at the time you annuitize the MYGA, your payout will be larger. FIAs with income riders do not provide this same interest-rate flexibility.
Surrender charge periods
Fixed Rate: The most popular fixed-rate annuities involve 3-, 4-, and 5-year surrender-charge periods. I’m currently recommending that 5 years is the longest duration you should consider to hedge against future rate increases, and I am also using short-term laddering strategies as well.
Fixed Index: The majority of FIAs sold are long-term surrender-charge products that are typically 10 years in length. Even though there are FIAs that have as short as a 4-year surrender charge, the 10-year version seems to be the most popular with agents. Always remember, the longer the surrender-charge period, the higher the commission.
Stanalysis: In a low-interest-rate world, it might make sense to shorten annuity maturities (both FIAs and MYGAs) in order to retain control and flexibility.
Fixed Rate: There are no annual fees with MYGAs, but surrender charges do apply during the specific time period of the contract.
Fixed Index: FIAs have no annual fees unless you attach an additional benefit rider. A typical income rider can carry an annual fee of 0.50% to 1% or more for the life of the policy. This fee is deducted from the index portion of the annuity calculation, not the rider value. Income rider and index-return values are separate policy calculations.
Stanalysis: FIA income-rider fees are not taken out of income-rider values, only the accumulation (index) value. However, that fee is deducted annually for the life of the policy. MYGAs have no annual fees for the life of the policy, and the guaranteed yield can grow and compound tax deferred.
Annuities should not be considered as market growth products. They should be owned for the contractual guarantees and fully understood for the good, the bad and the limitations of each policy. Yes, every annuity policy has its limitations and contractual realities.
So if you are pitched an indexed annuity with an income rider as the only solution for principal protection and potential future income, make sure that you compare it to a fixed-rate annuity. You (and your agent) might be surprised which one actually wins from a contractually guaranteed standpoint, and when it comes to asset control and flexibility.
Simplicity and efficiency are always good choices, so before you lock in a long-term surrender-charge indexed annuity, you need to compare it to a fixed-rate annuity. It might just be that transparent and flexible strategy you are looking for.
Originally published 4.22.2014 by MarketWatch.com – http://www.marketwatch.com/story/which-fixed-annuity-can-fix-your-retirement-2014-04-22