When I was a kid, my Dad bought me a swiss army knife at the local Homestead. I thought it was the coolest knife as I had every tool you could need conveniently in my pocket. Being a financial planner is much like being a swiss army knife. I literally have hundreds of financial tools at my disposal to accomplish a myriad of financial goals and objectives for my clients. Some are complicated. Some are very simple. One tool that I have seen a lot of interest in lately is fixed annuities. There are many types of annuities, but for the purpose of this blog, I am focusing on the fixed.
Rates: Before I get into the specifics, pros, cons and history of annuities, let's cut to the bottom line. The reason I am writing about fixed annuities today is the interest rates they are currently offering investors. In the last several years, we have seen Certificates Of Deposit (CDs) on an interest rate roller coaster. The rise in interest rates was fast, but most recently, we have seen rates fall. Today, Looking at the chart above, rates on the one year CD were their lowest in May, 2021 at 0.05%, rose quickly to a peak of 5.46% in October of 2023 and recently have fallen to 4.17% as of February of this year. Source: Federal Deposit Insurance Corporation 3/19/2025
Because of this recent fall, we are getting calls looking for higher rate investments. Fixed annuity rates today are above 5% for a three year and 5.5% for a five year. If you are a retiree living on a fixed income from your investments, this can be a substantial difference to your income and lifestyle.
If you have funds in low interest investments, a fixed annuity may be an investment to consider adding to your portfolio.
A little history: In 1759, a company in Pennsylvania was formed to benefit Presbyterian ministers and their families. Ministers would contribute to the fund, in exchange for lifetime payments.
In 1912, any American could buy annuities outside of a group. The Pennsylvania Company for Insurance on Lives and Granting Annuities was the first American company to offer annuities to the general public.
Annuities started to catch on in the late 1930s. Concerns about the overall health of the financial markets prompted many individuals to purchase products from insurance companies. In the midst of the Great Depression, insurance companies were seen as stable institutions that could make the payouts that annuities promised.
By today's standards, the first modern-day annuities were quite simple. These contracts guaranteed a return of principal, and offered a fixed rate of return from the insurance company during the accumulation period. When it was time to withdraw from the annuity, you could choose a fixed income for life, or payments over a set number of years.
What is it? A fixed annuity is a contract with an insurance company. You deposit your funds with the insurance company and in return they agree to return your principal to you after a set period of time (maturity) along with a fixed rate of interest. You also have an option to "annuitize the contract" and turn your funds into an income stream for life, period certain, etc..., Lastly, if you wanted to buy another annuity, you could perform a 1035 exchange which is simply a transfer from one annuity to another. This would allow you to continue the tax-deferred status of your funds.
Pro's:
Higher Interest: Unlike banks, insurance companies have the ability to invest in a broader range of investments and for longer time periods. They are then able to pay these higher returns to investors.
Tax Deferral: Because the funds are with an insurance company, the interest is tax-deferred until the investor either pulls the funds from the annuity or annuitizes the contract. This allows the investor to better control their annual tax liability as well as let their interest compound on a tax-deferred basis. Although this is a benefit, keep in mind that if you withdraw earnings before the age of 59 1/2, you pay the IRS a 10% penalty on those earnings because they are tax-deferred.
Options for payouts: Should you wish to annuitize the contract, there are many options to provide income including a "lifetime option" which is based on your age. The older you are, the higher the payout. Annuitization is much like a pension in the sense that you receive the same check for the rest of your life regardless of what the economy, interest rates, market, etc... does.
Con's"
Surrender Period: CD's generally have a maturity and if you choose to close your CD out before that maturity, you pay a penalty on the interest. With annuities, you pay a surrender penalty based on the year you take the funds out on the principal, not the interest. These penalties can be substantial. I only suggest annuities to clients that have a long term time horizon and who have adequate liquidity in other investments for an emergency. Pay attention to the surrender schedule when investing in an annuity.
On the bright side, many fixed annuities offer a "free out" which is an annual amount that the investor can take out without penalty. There may also be waivers for nursing home stay, disability and of course death. When purchasing an annuity, ask your financial advisor what the liquidity of the contract is along with the surrender schedule.
Longer Maturities: CD's maturities can be as short as a month. Most fixed annuities start at three years on the short end. Since the insurance companies are investing in longer term investments to pay out a higher rate, their investors must invest longer term as well. However, again, if you are simply looking for a fixed income and you have an emergency fund, the longer maturity should not be an issue.
Safety: Unlike a CD, annuities are not FDIC insured and are backed by the financial health of the insurance company. Fortunately for me, one of the services that I pay my broker dealer, LPL Financial, for is research. Every Monday, we receive a rate sheet. LPL's annuity department scrubs the long list of insurance companies for the highest rates from insurance companies that are financially sound. Generally, there is also another level of protection through state associations that the insurance companies are members of. In the state of Tennessee that association is The Tennessee Life And Health Insurance Guaranty Association. You can learn more about them HERE. In Tennessee that protection is $250,000 per investor per insurance company that is licensed to do business in the state of Tennessee. In my opinion, fixed annuities are a safe investment as long as due diligence is done on the insurance companies financial ratings.
Laddering: One of the pros and cons of the fixed annuity is the longer maturities. This can be good as it keeps your income steady and you don't have to be concerned with interest rate movements. It can be bad if you need money sooner than than the maturity date (I always make sure my clients have enough liquidity to meet an emergency) One strategy in fixed income investing is called laddering. Think of the rungs of a ladder as different fixed income investments. For example, if you have $500,000 to invest, you might have $100,000 in a six month, 1 year and 2 year CD and $100,000 in a three year and five year CD. You may earn less on the CD's but you have liquidity. You may earn more on the annuities but you are investing long term If rates go up, your shorter CDs are available to invest long term. If rates go down, you have your longer term annuities to boost your yield. I can help you build a ladder that suits your income and liquidity needs.
As mentioned, this is just one tool that I have available in my financial swiss army knife. It may or may not be right for you and If you come in for an appointment, I will find out your objectives and goals along with assess your financial situation. If this is an option, I will explain why. If it is not, I will explain why. If you want to set an appointment to discuss whether or not an annuity fits your needs, please call our office at 731-285-0097. It costs nothing but time and there is no obligation. We also have an annuity buyer guide that can be snail mailed or emailed. If you would like to know our highest fixed annuity rates and maturities, please call Kim or Charity. Again, rates change on Mondays.
Lastly, with the NCAA tourney starting up this week... GO VOLS!
Until Next Time, Cheers!
Disclosure: Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.