Safe Heaven Investment – Fixed Annuity

In today’s uncertain financial climate the quality of insurance company takes on new meaning. While no insurance company simply goes out of business due to highly regulated reserve requirements those companies are in danger from poor investment results or real estate loans may well be taken over by stronger companies.

While this generally means the new owner will abide by the guarantees of the original policy the “devil may be in the details.” When this happens the new company generally considers this a so-called “closed” book of business, a severely restricts your future options.

Fixed Annuity is a life time investment. This is a less travelled road in insurance. This (or other types of annuities) is the future of Indian insurance. Hence, before any investment, know the company and the product well.

This article is an attempt to demystify ‘Fixed Annuities’. Please read on.

Annuities are used to provide a future benefit in the form of a stream of payments. These payments are made within one year, in the case of an Immediate Annuity. They may also take place at some future date, more than a year, as in a Deferred Annuity.

A Fixed Annuity is a contract from an insurance company to pay money in the future. The company guarantees a fixed rate of return, usually based on some underlying bond crediting rate. The contract is between the insurer and the owner of the annuity contract.

A Fixed Annuity differs from Variable Annuities because the insurer backs the interest rate earned. A Variable Annuity permits the owner to invest the payments in the market for a potentially higher return. This also means that the owner of a Variable Annuity has a substantially higher investment risk. As such, Variable Annuities are registered security products; fixed annuities are not. One fixed annuity, the equity indexed annuity is also not considered a security.

Distinct Phases of Fixed Annuities

Fixed Annuities have two distinct phases: accumulation and annuitization.

During the accumulation or build-up phase, payments are made and grow on a tax-deferred basis. When the owner decides to receive income, the annuity is “annuitize” or paid-out. Payout can take place all at once or over years based on the life of an annuitant. The annuitant is similar to insured in a life insurance policy.

Difference – Annuities & Mutual Funds

Annuities are often compared to mutual funds and other investment products. This is a mistake because there are stark differences between the two. Fixed Annuities are not investment products. They provide a way to defer income for a period of time. Their guaranty return is unique and not found with mutual funds that face market risk. A Fixed Annuity has mortality and expense charges that are not found in investment products.

An initial payment into an annuity can be made all at once or over a series of period. These are single pay and fixed pay annuities respectively. Annuities enjoy tax advantages during the accumulation phase and sometimes may not be used until a specified age.

Taking money out prior to that age for purposes other than a special need may result in penalties and fees. Many Fixed Annuity contracts have what are known as surrender charges. A surrender charge is a declining fee, based on the number of years money is held. They can be as high as 30 percent and last up to 20 years.

Fixed Annuities are useful in planning for such life events as retirement. They may also be used to distribute lump sum payments such as inheritances. These are special Fixed Annuities known as structured settlement annuities. A Fixed Annuity gives ease of mind to a person who is uncertain about the market. They tend to be competitive with bank certificates of deposit but again are unique products.

When considering the purchase of a Fixed Annuity contract you should consult a licensed, professional and qualified insurance agent or financial adviser. A competent agent or counsellor can provide with comparative information and help determine the appropriate product. A Fixed Annuity may be valuable addition to product holdings.

To put it in plain speaking, fixed annuities are savings accounts for the insurance world. When you decide to invest in annuities with your insurance agent, you are agreeing to make payments over time which the agent, in turn, invests on your behalf. The fixed annuities you’ve invested in will gain interest over the years and can accumulate in cash value until the predetermined date you have selected to start receiving your pay-out.

Types of Fixed Annuities

There are five main types of fixed annuities. All these types may not be offered by the Indian insurers. I have listed them below with a brief explanation of each for knowledge purposes:

1.   Single-year guarantee fixed annuities – With this type the insurer guarantees to pay a specific interest rate for one year which they can raise or lower each year after until the contract ends with what are called “renewal rates.” There are a number of different kinds of renewal rates so ask the insurance agent which ones may apply to a given case, however in most cases the interest rate will consistently lower with each year.

2.   Multi-year guarantee fixed annuities – Here the insurer guarantees a specific interest rate for multiple years which cannot be raised or lowered. With this kind we know exactly how much we are investing and how much interest is being accumulated so we can know how much the pay off will be.

3.   Market value-adjusted fixed annuities – Perhaps the most risky and unpredictable venture, this variety is based on the market which is beyond our control and could lead to higher rates. There are penalties associated with breaking a market-value adjusted fixed annuities contract.

4.   Pass-through rate fixed annuities – With this the insurer receives a percentage of the fixed annuities and the insured will be paid the remainder of the interest earned.

5.   Floating rate fixed annuities – Here the interest rates vary from month to month and collect value according to the fluctuation rates.

Should I opt for a Fixed Annuity?

Examine & compare online insurance quotes or talk to a qualified professional insurance agent about fixed annuities to determine whether or not fixed annuities are right for you. Although they can be complicated, it is best to think of fixed annuities like a savings account in that we invest our money and it gains value as a result of accruing interest.

If this sounds like something interesting then fixed annuities are a worthwhile investment.

 

By : Dr. K. Raja Gopal Reddy, Phd, FIII, FCII(UK), FLMI (US),Chartered Insurance Practitioner., Published in Life Insurance Today, February, 2011