Fixed and Variable Annuity Differences
There are variable annuities and fixed
annuities. When newspapers and magazines mention
annuities they are almost always talking about variable
annuities. In a variable annuity, income or account
value is based on the
value
of the stocks or bonds backing the annuity assets, so
the income and/or account values fluctuate. Unlike fixed
annuities, the investment risk in variable annuities is
borne by the annuity owner; so variable annuities are
considered investment securities and would be a risk
money place.
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Fixed Rate |
Fixed Index |
Variable |
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Management Fees
|
No |
No |
Yes |
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Registered as Security
|
No |
No |
Yes |
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Guaranteed Prior Earnings
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Yes |
Yes |
No |
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Guaranteed Principal
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Yes |
Yes |
*No |
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Minimum Interst Guarantee
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Yes |
Yes |
No |
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*Yes in time of death |
Fixed Annuities
Fixed annuities provide a guaranteed minimum interest
rate and are considered savings instruments. All fixed
annuities are issued by insurance companies and are not
government or bank obligations so naturally they are not
FDIC insured. However, fixed annuities have an
extraordinary record of safety and offer other benefits.
Annuity Safety ... (click here)
Interest Earned & Minimum
Guarantees
Fixed annuities provide a minimum guaranteed return,
which is a safe money feature annuities have in common
with Series EE Savings Bonds, but unlike Savings Bonds
you do not need to wait 20 years for the annuity's
guarantee to kick in.
If the
insurance company believes they can pay extra interest
from their general account, above and beyond this
minimum guarantee, they will declare a fixed rate of
interest and pay the annuity owner a stated interest
rate for a period. Or, in the case of a fixed index
annuity, they could use the extra interest to link the
earning of interest to the performance of an external
index for a period. The major difference between a fixed
rate annuity and a fixed index annuity is in the
crediting of excess interest above the minimum
guarantee.
For More
On How Fixed Rate Annuities Earn Interest ... (Click Here)
More On How Index-Linked Annuities Earn Interest ...
(Click here)
Money remaining inside an annuity grows without being
taxed until withdrawn. Unlike qualified retirement
accounts where you must begin taking out money around
age 70½, most annuity contracts permit the owner to
enjoy the advantage of tax deferral until age 85, 90 or
even later. Tax deferred does not mean tax free,
interest is taxed when withdrawn. Also, the Treasury
charges a 10% penalty on interest, in addition to
regular taxes, if withdrawals are made before age 59½.
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Annuity interest grows tax-deferred. Money in
qualified plans grow tax-deferred. An annuity
inside, say, an IRA is already growing
tax-deferred because it is in a qualified plan,
which leads some people to say a fixed annuity
should not be used in a qualified plan. This
assumes the main reason one buys an annuity is
for tax-deferral; however, our research
indicates people buy an annuity primarily for
the potentially higher yield.
If your IRA choice was an
annuity yielding 6% or a similar
non-tax-deferred vehicle yielding 5%, which one
would you pick? The decision to buy an annuity
is primarily based on return, not tax benefits.
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For More On The Power Of Tax-Deferral
... (Click Here)
How Much Can I Put Away
Although one can find fixed annuities with a minimum
premium as low as $50, typically an annuity requires a
$5,000 initial premium ($2,000 for IRAs). Some annuities
are
single premium
- meaning that you cannot add to them, and others are
flexible premium
- meaning you may contribute more in the future if you
wish. Many carriers require advance notice if you are
going to put away more than a million dollars at a time.
Advantage Compendium reports the average annuity premium
is around $50,000.
Fixed annuities offer a wide variety of term choices.
The fixed annuity selected may have a penalty for early
withdrawal ranging from as short as a year to as long as
twenty years, although most permit the withdrawal of at
least the interest earned each year without penalty.
These penalties, also known as
surrender penalties or charges, are
used by the insurance company to recoup initial costs if
an annuity is cashed in prematurely., are
used by the insurance company to recoup initial costs if
an annuity is cashed in prematurely.
A
surrender penalty only becomes a charge if the policy is
surrendered, therefore you need to determine whether the
term of the annuity and liquidity provisions match your
liquidity needs.
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An MVA feature means changes in the interest
environment are taken into account if and only
if the annuity is surrendered prematurely. What
this can mean is if rates have risen since you
started the annuity the penalties for cashing
out could be higher than the schedule stated in
the policy and if rates have fallen since you
took out the annuity the penalties could be
lower or even zero.
The
reason behind Market Value Adjustments is found
in the Buyer's Guide To Fixed Deferred
Annuities produced by the National
Association of Insurance Commissioners. Since you and the insurance company
share the risk, an annuity with an MVA feature
may credit a higher rate than an annuity without
that feature. If you don't surrender the policy
during the period you never pay the MVA and
might get a little better rate.
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In the event of death the vast majority on fixed
annuities pay the account value to the named beneficiary
and no penalties are charged. Some annuities do assess
surrender penalties at death while a few others require
the account value to be paid out over time, so determine
if the annuity's terms meet your needs. If desired, an
annuity can be initially set up so that the surviving
spouse may keep the annuity in force.
*** The California Insurance Department
recently released an annuity report that says
"in
a fixed annuity the amount remaining in the annuity at
the annuitant's death stays with the insurance company." This is
WRONG
- it would only be true if you chose the most
restrictive annuitization payout option.
The insurance company
DOES NOT KEEP YOUR MONEY IF YOU DIE
when you own a deferred
fixed annuity. We hope California fixes this
incredible misstatement in their report soon.
Not to be confused with the surrender period, the
maturity date is the longest one can keep annuity
interest deferred before it must be taken out. Maturity
dates usually occur when the annuitant celebrates their
80Not to be confused with the surrender period, the
maturity date is the longest one can keep annuity
interest deferred before it must be taken out.
Maturity
dates usually occur when the annuitant celebrates their
80th to 90 birthday, but some
new policies may be kept until after age 100 (the
annuitant is the person upon which the annuitization
life income is based). A maturity date is not life
without parole. The maturity date is not how long
you must keep your annuity, but how long the insurer
will let you keep your money with them. To
repeat, the annuity owner may take their money out or
annuitize the contract prior to the maturity date. The
maturity date is the longest an annuity owner may force
the carrier to keep the contract, not the other way
around.
There are always costs, but fixed annuity fees and
expenses are not charged in the same way that a variable
annuity or mutual fund does, but more like the way a
bank does it.There are always costs, but fixed annuity fees and
expenses are not charged in the same way that a variable
annuity or mutual fund does, but more like the way a
bank does it.
Say the bank says they will pay 4%
interest on their CD. Okay, what are the bank's fees and
expenses on this CD? If your answer is you cannot tell
and it doesn't matter because all you really care about
is the final rate you get on your money, the same logic
applies to fixed annuities.
The insurance company doesn't deduct a management fee
and share a net return with the customer. Instead, just
like the bank, the insurer pays a fixed return, and this
may be stated as a fixed rate or as fixed participation
in an index.
Might some banks have lower operating costs or higher
revenues than another and thus offer a higher rate? Yes,
and an insurer could spend less on office supplies than
another insurer and thereby ultimately be able to pay a
higher rate on fixed annuities. But I don't know how you
translate all of this into fees?
Annuities do have penalties for early withdrawal if the
annuity is surrendered early, which is why one needs to
match the period with their goals, keeping in mind that
all annuities are designed to be long term savings
instruments.
States permit annuities to
charge annual contract fees of up to $50 a year
and many variable annuities do charge annual
fees, but I am unaware of any fixed annuities
charging this fee.
Fixed annuities do not subject principal and credited
interest to market risk. A fixed annuity is as safe as
the insurance company issuing the annuity and insurance
companies have an exceptional record of safety, which is
why they are a safe money place.
More on annuity safety ... (Click Here)
There are two ways fixed annuities credit interest. They
either pay a stated interest rate that you know in
advance of each period, or they link the interest paid
to performance of an index and state the what your
participation in the index will be.
More
On How Fixed Rate Annuities Earn Interest ... (Click
Here)
More On How Index-Linked Annuities Earn Interest ...
(Click Here)
- What is the initial rate and how long is it
guaranteed?
- Does the initial rate include a bonus?
- Are there any special requirements to receive
the bonus or to cash out the annuity?
- What is the guaranteed minimum return?
- Are there any fees?
- Are there surrender or withdrawal penalties or
charges?
- Is there a Market Value (MVA) Adjustment?
- Do the surrender costs still apply at death?
- What rate is being credited on similar
annuities issued in the past?
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