3 Risks To Consider Before Investing in Fixed Annuities

My Personal Finance Journey Homepage

Today’s guest post comes to us from Lisa Cintron on behalf of OnlineAnnuityRates.com.

Annuities are savings instruments issued by insurance companies to individual investors. The annuity contract specifies the amount and time period for the premiums to be paid. It also specifies the amount and time period for payments to the investor after the premiums are paid. Fixed annuities do not invest in stocks, only fixed income assets such as bonds and guaranteed insurance contracts. Fixed annuities have guaranteed principal and payment amounts that do not change.

Advantages of Fixed Annuities

▪ Investors prefer fixed annuities for guaranteed principal and interest by issuing insurance company.

▪ Tax deferred compounding of interest until payment request.

▪ Issuing company rating by Moody’s, Standard & Poor, Fitch and A. M. Best easily accessible. Typically, you want to seek out companies rated AAA to minimize your risk.

▪ Underlying fixed income investments are safer and more stable than equity (stock) based investments.

Fixed annuity potential risks

There are some possible risks associated with fixed annuities. All investments have some form of risk. Investors need to weigh these risks against the rewards of fixed annuity investments. They are as follows with details discussed below:

▪ Inflation risk.

▪ Interest rate risk.

▪ Low liquidity risk.

Inflation risk

A fixed annuity’s biggest attraction for most investors also presents risk to investors. The guaranteed principal and interest offers no protection from inflation. Financial planners emphasize that the biggest threats to an individuals savings and investments are taxes and inflation. The longer the period for premium payments and any deferral of payments gives inflation more time to erode the future purchasing power of the dollar. E. g., a fixed annuity guarantees a payment of $200.00 monthly 30 years from now. If 30 years from now the dollars purchasing power declines by 25%, The $200.00 payment then only buys $150.00 in todays economy. A simple and effective method to offset this risk is to diversify investments into stocks or mutual funds which provide higher potential rewards on a long term basis.

Interest rate risk

A fixed annuity guaranteed principal and interest also generates interest rate risk. This is basically a loss of opportunity to acquire higher rates of return as interest rates go up during the purchase and deferral stages of an annuity. If an annuity guarantees a 3% interest rate and interest rates go to 6%, investors lose the ability to double their rate of return. Investors can offset this risk by purchasing a variable annuity. Variable annuities returns are based on the actual returns of the annuity’s portfolio. Some Variable annuities invest in stocks, usually through mutual funds, This gives investors the ability to realize some of the higher returns available when interest rate or stock returns are up.

Low liquidity risk

Fixed annuities are very inflexible about accesssing funds during the accumulation phase. This gives the annuity investment managers some stability to allow them to make long term investments which pay higher returns. Any withdrawals over 10% a year can be penalized by the annuity. Check the annuity contract for details on this if an early withdrawal may be needed. A good way to offset this risk is to maintain emergency funds. Most financial planners advise at least 6 months expenses set aside for dire needs like unemployment or unexpected medical expenses.

How about you all? Have you ever used annuities? What was the risk you were most worried about? 

Please Share your experiences by commenting below!

Did you like this article? You can get the complete text of all the latest articles at My Personal Finance Journey in your email inbox each evening by clicking the link below and entering your email address. Your address will only be used for mailing you the articles, and each one will include a link so you can unsubscribe at any time.

Subscribe to My Personal Finance Journey via Email

***Photo courtesy of http://cdn.bloggingwithsuccess.net/wp-content/uploads/2010/08/look-before-leap.jpg

Speak Your Mind


CommentLuv badge