Fixed Annuities and Your Selection of Annuity Rates

Got a question about this topic? Just ask it in the comment box below and the editors will answer!

When it comes to fixed annuities, you have three common structures from which to select annuity rates.

The oldest and most common traditional fixed annuity is the type that pays a fixed annuity rate for the first 12 months and then adjusts the annuity rate every 12-month period thereafter. The typical term for these annuities is anywhere from 5 to 15 years. The potential problem is as follows. Once you make your investment, you are locked in by early withdrawal penalties. In the insurance industry, these are called surrender charges. Should you withdraw more than a nominal amount in any one year, the surrender charges will be inflicted against your account and could cost you quite a bit. So if the annuity company decides not to pay you very competitive annuity rates after the first 12 months, you're pretty much locked into taking what ever annuity rate they give you.

The next version of the fixed annuity you typically find will have a guarantee of annuity rates for several years. As a hypothetical example, let's say that the annuity has a 10-year term. But for the first five years it guarantees a rate of say 4%. In this case, you certainly have better security than in the previous illustration because your rate is locked in for a period of time. However, the annuity rate could drop considerably in the latter five years leaving you stuck in the annuity with significant surrender charges if you try and leave.

The third type of annuity, the multi-year guarantee annuity, removes all of the risks discussed above. In this case the annuity rate is fixed for the entire term of the annuity. For example, if you select a 10-year annuity paying 4%, you will get 4% every year for the entire term, no more no less. Note, that should annuity rates go up, you may be sorry you made this choice because you will not get any more interest. In such a scenario, the first annuity we reviewed may fair far better because its annuity rates adjusts every 12 months. But you would only fair better if the annuity company adjusted you upward in line with the upward trend in annuity rates. While you never know what the annuity company will do in the future, you can check its interest rate history.

In all cases above, at the end of the term, you are free to stay with the annuity company and pt for several options they will provide.  These options include renewing your annuity for the same period, leaving your annuity as an open account (at very low rates) or annuitizing and receiving a stream of payments.  You can also transfer your balance to another annuity company in a tax-free exchange. You could also cash in the annuity but very few people do so to avoid paying a large tax bill at one time.