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Fixed Annuities

Traditional annuities earn a fixed rate of interest and pay a fixed income.
When you buy a fixed deferred annuity contract, you get two promises from the issuer: a fixed rate of return during the build-up period while your retirement savings accumulate, and many ways to receive retirement income, including payments that are guaranteed to continue for as long as you live. The two promises are related. Your money in the annuity is tax deferred until you're ready to withdraw. The earnings rate paid on your savings, the amount you save, and the length of time your annuity grows all determine the income you'll receive. For many people, the certainty of a fixed rate of return is a chief attraction of fixed annuities. Equally important, the rate you're paid is guaranteed by the company issuing the contract, regardless of whether interest rates move up or down.
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SETTING THE RATE The company that issues the annuity sets the current rate of interest it will pay on its contract with you and revises it periodically. Rates may be adjusted monthly, annually, or less frequently. When the rate changes, it sometimes increases and sometimes decreases to reflect what's happening in the economy at large. But it can never go below the guaranteed rate that's set when you buy the annuity. In general, the new rate is based on the return the company is earning on its own investment portfolio, typically government and corporate bonds and residential mortgages. The spread, or difference between what the issuing company expects to earn and what it commits itself to pay out, can help offset some of its expenses and provide some of its profits. You can comparison shop for earning potential as well as for high ratings and financial strength of the insurance company providing the annuity. The fact that renewal interest rates tend to be lower than introductory, or first-year rates, can complicate your comparison of earning potential. One solution is to compare older polices as well as the new ones offered by the same insurance companies.


The amount you invest to buy a fixed annuity contract goes into the provider's general account, along with premiums from other investors and other company revenues. Because the company has such large sums to invest, it can diversify its holdings and potentially earn a better return on its investment for the same investment risk than you could as an individual. A potential downside of buying a fixed annuity may occur if the issuing company gets into financial difficulties, since its creditors would have a right to assets in the general account. Such situations aren't common, though, in part because the insurance industry is heavily regulated and individual companies are rated regularly. But be alert: Companies touting fixed annuity returns that are much higher than the rates offered by the competition may be too good to be true. Sometimes, promises of stellar returns are a red flag that annuity money is going into riskier investments such as junk bonds. Before buying, ask to see the rate that the issuing company has paid over the past ten years and be sure to check the company's ratings.


Fixed annuities, sometimes called guaranteed annuities, are generally described as safe because you can count on receiving the specific return you're promised each year. The guarantee is backed by the insurance company issuing the annuity, not the government. But if you buy your contract from a highly rated company, its financial strength and reputation stand behind your contract. Rating services such as Standard & Poor's, Moody's , AM Best, and Fitch rank annuity providers on their overall financial condition, which underlies their ability to meet their obligations. These reports are available in public libraries, on the Internet, from your financial adviser, and from the insurance company if you request it.
THE INFLATION ISSUE The flip side of safety, or the promise of guaranteed return, is that the amount you get does not increase with inflation the way that Social Security payments do. The major risk of any fixed income source is that your costs will increase over time, but the income you receive will not. If inflation should increase rapidly, as it sometimes does, an income that was once adequate may leave you short of cash. And the longer you live and continue to collect, the less far your fixed income is likely to stretch even if inflation increases only modestly.
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