Fixed, Indexed and Variable Annuity Rates
Investors searching for the best variable annuity rates for their needs have three options: Fixed, indexed and variable. As financial investments, each of the three has advantages and disadvantages. While each can provide a guaranteed stream of retirement income, investors are always advised to ensure that their financial needs and risk tolerance are properly suited to the type of annuity they choose.
Annuity rates vary depending on the type of annuity chosen. Fixed annuity rates are normally lower than the rates of variable or indexed annuities, but the erosion of principal is less likely. Indexed annuities are more balanced than variable annuities, but indexed annuity rates are often capped and don’t pay the entire percentage gain of the index. Variable annuities can grow faster than indexed annuities, but can also incur significant loss of principal if the funds in which it is invested suffer losses.
Fixed Annuity Rates
A fixed annuity invests primarily in bonds, specifically United States treasury bonds and bills. Treasury bonds are long-term debt obligations with maturity dates of more than 10 years. Treasury bills are short-term debt obligations with maturity dates of less than one year. Both are backed by the United States government and are considered to be the safest investment in the world. But that safety translates into a lower return.
Some fixed annuities will also invest in state issued bonds or very high quality corporate bonds in order to boost return. Whatever the bonds are that the company is investing in, a fixed annuity investor can be assured that the credit rating of the U.S. government and any states or corporations will be extremely high. The risk of a government or company defaulting on the bond will be practically zero.
The life insurance company that issues the annuity contract sets the fixed rate. But it won’t be as high as an investor could get if he were to purchase the investments directly. That’s because the insurance company must employ a staff to manage the contract and the investments within the fund. Further, the life insurance company will guarantee that distributions or payouts will be made to the owner of the annuity at a guaranteed rate, regardless of the rate paid on the bonds.
For example, if the investor has been guaranteed a 2.00% rate, but the new T-bills that the life insurance company must purchase in order to generate income now only pay 1.5%, the company must pay the investor the 2.00% rate.
Indexed Annuity Rates
Indexed annuity rates are tied to a specific market index, such as the Standard & Poor’s Index (S&P 500). The S&P 500 is an index of the 500 largest stocks in the United States. Stocks are selected based primarily on market capitalization, liquidity and market sector. Market capitalization is the size of the company as figured by the number of shares outstanding and the price of those shares.
Liquidity is the ability stock traders, including retail traders, have to buy and sell the shares easily. Market sector is the segment of industry that the company is in. For example, Microsoft is in the Information Technology sector. Because it contains the largest companies, the S&P 500 is therefore considered the leading benchmark of the United States stock market.
There are currently 10 sectors in the S&P 500. This provides almost immediate diversification for an indexed annuity. One sector can experience sharp declines while another enjoys significant advances. This minimizes risk and offsets some losses against some gains. Investors are cautioned, however, to make sure that they can withstand the erosion of principal that can happen in a broad sell-off. If the S&P 500 loses value, then the value of the indexed annuity is reduced as well.
Because it is so broad, the S&P 500 is the index most often used for indexed annuities. An indexed annuity’s rate, then, is tied to the performance of the S&P 500. If the S&P 500 increases by 3%, then the indexed annuity rate earned is 3%. However, because there are management fees incurred to establish and manage an indexed annuity, most insurance companies will cap the maximum amount that can be credited to an indexed annuity. If the cap is set at 5%, only 5% will be credited to the account even if the S&P 500 increases by 6%.
Variable Annuity Rates
Whereas fixed annuity rates are based primarily on bonds and indexed annuity rates are based on the performance of a market index, variable annuity rates are based on the performance of equities. The premium invested in a variable annuity is used to purchase equity mutual funds. Depending on his or her own level of risk tolerance, each investor can choose the funds in which the premium is invested.
Investors who are risk averse may choose ultra-conservative stock funds in an effort to increase the value of the annuity without risking much of the principal. Investors who can tolerate more risk, for example, younger investors with a longer time horizon or those with substantial additional investments, may choose highly aggressive funds. The mutual fund choices can also include foreign funds, emerging market funds and funds that contain the stocks of smaller companies.
One very important feature of a variable annuity is the death benefit. Should the owner of the annuity die before he or she begins to receive distributions, the beneficiary will be paid a specific amount. The amount differs among insurance companies, but is most often at least the amount of the premiums that were paid in. If the value of the variable annuity is less than the premiums paid in due to poor performance of the mutual funds, the beneficiary will receive at least the remaining value of the annuity.
Variable annuity rates, like the value of the annuity itself, will vary based on performance. While some investors will see the value of the investment grow, others will not. Therefore, investors are always advised to make sure that the annuity rates they are trying to achieve are within their risk tolerance level and that they can withstand a loss of principal.
Professional help is a MUST given the nuances of annuity products. For free help, advice, and actual product comparisons, get in touch with a qualified financial advisor right now!