Although interest rates are rising they’re still pretty low by historical measures, so it's hard to get a safe, reliable return on savings—especially for retirees who may have a relatively short timeframe. Variable annuities, which invest in mutual fund-like sub-accounts, can post decent gains depending on the vagaries of the market, but they're also subject to market volatility. What about the more secure portion of a retirement plan? Can fixed-rate annuities help build returns?
Annuity Benefits
Philip Chao, chief investment offer and principal at Experiential Wealth in Cabin John, Md., notes that fixed annuities typically credit accounts at a higher rate than money market or government bond funds. That's because the insurance companies behind them can invest client premiums in a diversified portfolio, including longer-term instruments. "This allows them to credit above market returns," he said.
Todd Giesing, senior director of annuity research at data tracker Secure Retirement Institute in Windsor, Conn., said fixed-rate deferred annuities were big sellers in 2020—clocking in at nearly $52 billion for the year, the highest recorded sales record since the Great Recession.
"Continued market uncertainty made [them] attractive for investors looking for safe, short-term investment growth," he said. "Because these are short-term contracts, investors can reevaluate their strategy when interest rates return to normal levels."
Single premium fixed-rate annuities, sometimes called multiyear guaranteed annuities (MYGAs), are "definitely worth considering as part of the fixed income/safe portion of an older investor’s portfolio," said David Blanchett, head of retirement research at Morningstar. Where some fixed annuities might guarantee an interest rate for only part of the contract term, MYGAs guarantee the rate for the entire contracted term, like CDs. Though they are not FDIC-insured like CDs, they are contractually guaranteed and many come from carriers with high credit ratings.
Other Benefits
Moreover, annuities "offer unique tax-deferral opportunities," says Dylan Tyson, president of Prudential Annuities, a unit of Newark, N.J.-based Prudential Financial. Specifically, unlike with CDs or bond funds, the interest comes tax-free until you take distributions.
Michael Guillemette, an assistant professor at Texas Tech University's School of Personal Financial Planning in Lubbock, Tex., noted that bonds, in comparison, have "no upside potential due to the low interest rate environment."
At the moment, in fact, bonds present some added risk. If interest rates rise (as expected), bond prices fall. "As we saw at the end of 2020," said Craig Borkovec, a financial advisor at Los Angeles-based Miracle Mile Advisors, "bond prices fell while the income component of that bond went unchanged."
Yet another feature of many annuities is that clients can only take out so much at a time. The annuity "protects the investor from making early withdrawals that are too large," observes Paul Samuelson, co-founder of LifeYield, a wealth management firm in Boston. He added that some may consider that a disadvantage.