Why Investors Should Consider Fixed Annuities in their Portfolios
Oct 4, 2022
Blueprint Income Team
A fixed annuity also known as a MYGA can be a smart investment choice for those looking to diversify their portfolios while earning higher than bank deposit rates.
If you are an investor with access to liquid capital and are interested in a source of growth potential outside of an increasingly volatile market, consider investing in a fixed rate annuity (MYGA). In retirement, an annuity can also provide you guaranteed income to supplement your other retirement income.
While the word “annuity” is often plagued with confusion because of the wide variety of products available and the associated terms and fees, fixed annuities generally operate similarly to a certificate of deposit, commonly known as a CD. and are easy to understand. We note that annuities are guaranteed by their issuing insurance company, whereas CDs are insured by the FDIC.
The most common type of fixed annuity is a guaranteed fixed annuity with a set interest rate that remains in effect for multiple years, also called a multi-year guaranteed annuity, or MYGA. By guaranteeing a rate over multiple years, MYGAs aim to offer more stability and predictability than other types of annuities. With the MYGA, interest rates and contract term are specified up front. This means that since the rates are locked in, your contract can stipulate exactly how your money may grow for the entirety of the contract term.
- Guaranteed return: With a MYGA, the initial rate and terms are specified up front. While, the renewal rate (after the initial rate matures) may be higher or lower than the initial rate, it can be no lower than the minimum interest rate stipulated in the annuity contract.
- Tax-deferred growth: A key benefit of fixed annuities (MYGA) is their ability to be a safe harbor from taxes. As long as the funds are kept in the fixed annuity, the investor will not owe taxes on the gains. Tax-deferral allows interest to compound faster – this ultimately helps investors grow their savings more quickly than a CD, where gains are taxed each year when credited even if the gains cannot be accessed without a penalty.
Exhibit 1: Yearly Gains on $100,000 Invested in a 5-Year Fixed Annuity vs. a 5-Year CD.
The below graph shows how a 5-year fixed annuity’s higher APY rate, combined with tax-deferred compound interest, produces progressively increasing gains that exceed 5-year CD returns on both a yearly and cumulative basis. Investors can also utilize fixed annuities as a tool to grow savings until hitting retirement, when one may then be at a lower tax bracket.
Graph shows assumed rates of return based on a $100,000 investment in a 24% federal tax bracket and is not indicative of any particular investment product’s return. Source: Fixed annuity rate of 3.15% APY quoted in February 2022 taken from Blueprintincome.com. 1.3% CD rate quoted in February 2022 taken from Bankrate.com. This chart does not show the taxes that would be due on any withdrawals from the annuity. If it did, the yellow line would be lower.
- Principal protection: Fixed annuities offer investors a way to shelter their capital from market downturns, essentially eliminating market risk. As an added benefit, there are no contribution maximums for a fixed annuity. In this regard, fixed annuities can be a good option for those who do not want to risk their retirement funds to market forces, or for those who want broader diversification to reduce the overall risk of their portfolios.
- Some liquidity: Fixed annuities are typically used as long-term investments but do allow early withdrawal. If you are over 59½, fixed annuities offer more liquidity because you avoid a 10% federal tax penalty when withdrawing funds. For this reason, fixed annuities might be more suitable for investors who might be less likely to need such funds pre-59½.
- Simplicity: A key benefit to fixed annuities is that they are easy to understand based on the contract terms, and as a result, are less complicated than other annuities, such as variable and fixed index annuities which come with a complex structure and nuanced investment terms and fee provisions. Fixed annuities have no hidden fees and offer predictable results as long as no withdrawals are made. And unlike CDs, fixed annuities do not go through the costs and delays of probate upon the death of the individual – a beneficiary can simply be named and changed as needed.
In short, anyone considering CDs should take fixed interest annuities into account. As of March 8th, 2022, investors can earn up to 3.27% annually on a five-year fixed annuity. In comparison, the top five-year CD rate was 1.80%.
The higher rates and tax-deferred status of fixed rate annuities are compelling reasons to opt for them over a CD as it means that the initial lump-sum amount – your hard-earned capital – can grow worry-free by earning interest each year, at higher than CD rates, without needing to pay annual income taxes on the growth.
Blueprint Income Team
We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.