Markets Insight
  •  7/15/2021

Fixed Annuities for Simple, Fixed Rate Growth and Protection

By SIMON

A “hitting singles” approach to preserving retirement assets that provides protection of premium and guaranteed rates.

What Are They and How Can They Protect a Portfolio?

A fixed annuity is a tax-deferred contract issued by an insurance company. It is designed for the long term and may offer the contract owner:

A fixed annuity can also be fine-tuned to provide lifetime income, though this article will focus on its use during the accumulation phase of retirement planning.

In their simplest form, fixed annuities can be described as the insurance industry’s version of a Certificate of Deposit (CD). When you buy a CD from a bank, you give them money for a specific period of time and the bank pays you interest on that money each year. The bank guarantees all of your money back at maturity. However, there is typically a penalty if you redeem the CD prior to maturity.

Fixed annuities work similarly. You give your money to an insurance company and in return, the insurance company pays you interest at a guaranteed rate for 1–7 years. You can withdraw a “free annual withdrawal amount,” typically up to 10% of your fixed annuity account value, each year without incurring any penalties should you need to access some of the funds. However, withdrawals exceeding the free annual withdrawal amount during the surrender charge period (which typically ranges from 3–10 years), will generally carry an early withdrawal charge called a “surrender charge.”

There are a few key differences between fixed annuities and CDs:

Types of Fixed Annuities

Fixed annuities typically fall into one of two categories:

  • Annuities that credit interest one year at a time, with the carrier setting a new fixed rate each year, or
  • Annuities that guarantee a specific interest rate for the entire length of the surrender charge period

Traditional Fixed Annuities That Guarantee a Rate One Year at a Time

The first fixed annuities that were introduced in the early 1980’s guaranteed rates one year at a time. This design continues to this day. Typically, this 1-year rate will be higher than a 1-year CD. But, there is a trade-off. The rate is only good for one year, as the carrier will reset the rate at the end of each 1-year period. The idea is that the insurance company can pay you a higher rate if rates go up and a lower rate if rates go down (subject to a minimum rate that is specified in the contract), however the fixed rate is at the insurance company’s discretion at each renewal. Fixed annuity contracts with 1-year rates also have a surrender charge period, typically 7–10 years, during which any withdrawals from the annuity contract will be subject to a surrender charge.

If you buy a fixed annuity with this design, it’s very important that you are comfortable with the history of the insurance company’s renewal rates.

Multi-Year Guaranteed Annuities (MYGA)

In response to concerns about what future renewal rates would be, the industry introduced fixed annuities that guarantee a rate for the entire length of the surrender charge period. These contracts typically come in 3-, 5- and 7- year terms. Within the insurance industry, these are referred to as Multi-Year Guaranteed Annuities, or MYGAs. These contracts are straightforward. If you put $100,000 in a 3-year fixed annuity paying 2.25% for each of the 3 years, you know that at the end of the 3-year period, you will have exactly $106,903.  At that point, you can either elect to renew for a new term at the rate offered by the carrier, move the money to another tax-deferred retirement vehicle or account, or  receive your money and pay taxes owed.

Remember however that annuities, unlike CDs, don’t actually mature. Should you elect to leave your money in the existing annuity, one of two things could occur, both of which would be outlined in the contract.

  • Some carriers will automatically move you into a new surrender charge period of the same length of time as the one that just matured. For example, if you previously had a 3-year rate guarantee, you would get a new 3-year rate guarantee and a new surrender charge period would begin.
  • Other insurance companies will automatically start you at a new rate for a one-year term. In these cases, the surrender charge period will not start over again. Since you have completed the initial surrender charge period and you now have the flexibility to withdraw your money at any time, the insurance company will typically provide a lower 1-year interest rate than if you were to renew for a longer term.

Market Value Adjustments and How They can Impact Your Annuity Value

If you buy a MYGA, your rate guarantee will most certainly come with a market value adjustment (MVA) that will be assessed if you withdraw funds that exceed the annual free withdrawal amount from the annuity prior to the end of the surrender charge period. A MVA is in addition to any surrender charges, and exists to protect the insurance company against an increase in interest rates in the event of early withdrawal.

One important concept to understand about a MVA is that if interest rates have increased since you bought your annuity, the MVA will further reduce the account value of your annuity, and any withdrawal amount you receive. On the other hand, if interest rates have fallen, the MVA will increase the account value and any withdrawal amount you will receive.

It's also important to note that this MVA calculation is only assessed if you get out of the contract before the end of the surrender charge period you selected. If you selected a 5-year surrender charge period and you wait to withdrawal funds in the annuity until the term is over, no MVA would be assessed.

Things to Consider Before Buying a Fixed Annuity

To recap, fixed annuities may be an attractive addition to a portfolio if you seek:

  • Protection – of your premium invested
  • Predictability – without exposure to market risk
  • Simplicity – with a guaranteed rate of return over a defined period of time
  • Competitive, Tax-Deferred Rates – compared with a bank CD, however holding periods for fixed annuities can range from 3–10 years, depending on the type of fixed annuity

However, there are several important considerations to understand, including:

  • When interest rates are renewed, they are at the discretion of the insurance company and may be lower or higher than the previous guaranteed rate.
  • Early withdrawals that exceed the free annual withdrawal amount during the surrender charge period may trigger surrender charges, fees, and/or tax penalties, and may be subject to negative adjustments, which could be substantial. Early withdrawals that exceed the free annual withdrawal amount may also be subject to a market valuation adjustment, or MVA, which can reduce the account value or the actual withdrawal amount. For this reason, an investor should be prepared and able to hold an annuity through the full length of the surrender charge period which is typically between 3–10 years.
  • Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59 ½ , may be subject to an additional 10% federal income tax penalty.
  • Fixed annuities are not FDIC-insured. All references to guarantees arising under the annuity contract, including optional benefits, are subject to the claims-paying ability of the carrier.

To find a fixed annuity solution that can work for you, reach out to your financial professional and carefully review the fixed annuity’s offering document, disclosure document, and buyer’s guide for important contract details, including fees and charges.

Want to learn more about managing market risk with confidence? If you’re a financial professional, contact SIMON for a demo and if you’re an investor, ask your financial professional about SIMON.

You can also learn more about annuities and other risk managed solutions with articles and videos available on simon.io/engage.

© 2021 SIMON Markets LLC. All Rights Reserved. | 2021.07

This is not intended to be an offer or solicitation to purchase or sell any security or to employ a specific investment strategy. This material is intended as general background information, for educational purposes only, and should not be used as a primary basis to make a decision to purchase an annuity contract. This material is being provided for informational purposes only and does not take into account any specific investment objectives or financial situation of any investor. The information is not intended as investment advice and is not a recommendation about managing or investing retirement savings. Actual fixed annuity contracts may differ materially from the general overview provided.

Prior to making any decision with respect to an annuity contract, purchasers must review, as applicable, the offering document, the disclosure document, and the Buyer’s Guide which contain detailed and additional information about the annuity. Any annuity contract is subject in its entirety is to the terms and conditions imposed by the Carrier under the contract. Withdrawals or surrenders may be subject to surrender charges, and/or market value adjustments, which can reduce your contract value or the actual withdrawal amount you receive. Withdrawals and distributions of taxable amounts are subject to ordinary income tax and, if made prior to age 59½, may be subject to an additional 10% federal income tax penalty. Fixed Annuities are not FDIC-insured. All references to guarantees arising under an annuity contract are subject to the financial strength and claims-paying ability of Carrier. This does not constitute legal, accounting or tax advice, and the recipient should consult with his or her legal, accounting or tax adviser regarding the instruments described in this material.

Securities products and services offered by SIMON Markets LLC, a broker-dealer registered with the U.S. Securities and Exchange Commission, a member of FINRA / SIPC. Annuities and insurance services provided by SIMON Annuities and Insurance Services LLC. Please visit www.simon.io for complete disclosures, including terms of use and privacy policy.

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