Investors saving for retirement or looking for guaranteed income once they’ve reached retirement have a number of investment options from which to choose. Those with several years until retirement are often urged to invest in more aggressive products such as equities, equity exchange traded funds and variable annuities. For those who are on the verge of retirement or those already retired, a Certificate of Deposit, Treasuries and immediate fixed annuities are generally the safest places to save.
Comparing Annuities to Mutual Funds
Mutual funds, especially equity mutual funds, are a good way for investors to save for retirement and diversify their portfolios at the same time. When part of a retirement account, all earnings grow tax-deferred. But after retirement, investing in an index or variable annuity may be a better option for one very important reason: Taxes.
All annuities, whether they are part of a retirement account or not, grow tax-deferred. That leaves more money in the account to compound and grow over time. Even investors past retirement age of 62 or 65 need some growth within their accounts to offset the effects of inflation. Because the payouts on annuities are considered to be the return of premium, only the amount earned is taxed.
With mutual funds, even if the investor does not take a distribution, he or she will owe taxes if the fund has realized capital gains on stocks it has sold within the fund. He or she will also owe taxes on dividends paid on stocks within the fund. In other words, an investor has no control over a portion of his or her capital gains or dividends tax liability when it comes to mutual funds.
Comparing Annuities to Stocks and Equity ETFs
Stocks and equity exchange traded funds (ETFs) offer investors a share in the earnings of a company. The dividend paid by a company is a reflection of the earnings. Quarterly dividend checks are often a staple among retirees. However, there is no guarantee that a company will not reduce the amount of its dividend or cease to pay it altogether should it need to conserve cash for one reason or another.
When looking for guaranteed income, investors may want to consider an immediate fixed annuity. The monthly payout is guaranteed by the insurance company and can continue as long as the investor wishes. He or she can choose a guaranteed stream of income for a predetermined number of years or for life. Even if the returns on the insurance companies investments are reduced, it must pay the investor the guaranteed amount.
Comparing Annuities to CDs
Certificates of Deposit (CDs) are one of the safest investments an investor can make. The Federal Deposit Insurance Corporation (FDIC) insures CDs like any other bank account, up to $250,000. The money used to purchase a CD is locked-in for the duration of the term, which can be as few as seven days to as long as 72 months. While there is usually a minimum deposit amount required to receiving the highest interest rate available, most banks today are paying between .16% on the shortest term CDs and 2.00% on the longest term.
CDs are best for preserving, not growing, savings. The rate paid by the bank is usually a bit higher than that paid on a savings account. However, at 2%, the danger is that over time the CD actually loses money because it is not keeping pace with inflation. Further, because the money used to purchase a CD is locked in, should interest rates rise before the expiration of the term, an investor will lose out on the higher rate.
Comparing Annuities to Treasuries
United States Treasury bills, notes and bonds are considered to be among of the safest, if not the safest, investment available. Treasuries, like all bonds, are debt. The Treasury sells the debt of the US federal government so it can finance ongoing operations. In exchange for buying debt, an investor is rewarded with a fixed return.
A Treasury bill, or T-bill, is a short-term debt obligation. The three term lengths for T-bills are four, 13 and 26 months. They are sold in denominations of $1,000 up to a maximum of $5 million through a bidding process. T-bills are sold at a discounted rate. The total value of the T-bill is returned to the investor through appreciation. For example, an investor who purchases a three-month $10,000 T-bill priced at $9,700 will receive $10,000 at the end of the three-month term.
Treasury notes are longer-term debt obligations. The term can be from between one to 10 years. Treasury notes are purchased by placing a competitive bid for a specific yield or by placing a noncompetitive bid if an investor will accept the yield offered by the Treasury. The income derived from Treasury notes is not subject to state or local taxes. This can be a significant advantage for those who live in states with high taxes such as California or New York.
A Treasury bond, or T-bond, is a long-term debt obligation with a term of 10 or more years. Income from Treasury bonds is also only taxed at the federal level. Like Treasury notes, T-bonds are offered at both competitive and noncompetitive bid.
While Treasuries are a very safe way to save money, the return on the investment will almost always be lower than that of a fixed annuity. Bonds can also be called in or discontinued. Rates on new Treasuries sold can vary from month to month depending on the amount offered at auction and the total amount of outstanding debt. And, while the credit rating of the United States is currently exceptional, mounting debt and an uncertain economy may combine to reduce the ability to maintain its high credit rating.
A fixed annuity will provide guaranteed income for life or for a specific period of time. Regardless of what happens to the underlying investments, whether they are Treasuries or corporate bonds, the insurance company is obligated by contract law to pay the rate it has guaranteed in the annuity.
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