Fixed Annuities

Over the years the President of Secure Retirement, Richard Morey, has spoken to numerous groups of retired investors. He often asks them how much of their retirement money they could lose before they would become concerned or upset. Approximately one-half of retirees say the answer to that question is zero. In other words, they never want to lose any of their retirement money, no matter what happens in the economy or markets.

If you search the world for investments that never go down in price, you find only a few candidates. These include Certificates of Deposit or CDs, savings and (most) money market accounts, U.S. Government bonds held to maturity, and fixed annuities.

Unfortunately, CDs, savings & money market accounts, and Government bonds are some of the worst investments imaginable at this time. This is due to the fact that interest rates are lower than they have been at nearly any point in history. As a result, over time these investments are basically guaranteed to lose buying power due to inflation. This may not affect a retired person today or tomorrow, and in 2008 these were certainly better places to have money than almost any other market in the world. But over any extended time period, earning less than inflation is seriously dangerous to your financial health.

Fortunately, fixed annuities offer a much better alternative for people who want to have an investment with guaranteed principal. Over the last six years, approximately 75 clients have asked us to invest their money in something that would never go down, at all, in price. Overall, the annuities we have used have gained 4-6% a year – including 2008. While obviously not huge profits, these have clearly been one of the best choices for retirees in this economic and interest-rate environment.

Please note that fixed annuities are completely different from variable annuities. We have never used a variable annuity at Secure Retirement, as most are essentially expensive combinations of mediocre mutual funds. If a person wants to assume the risk of mutual funds, we would much rather use the funds we purchase for our clients at Charles Schwab & Company. These funds have earned much more than most if not all the funds inside any variable annuity, they are safer, and they cost much less than the funds inside variable annuities. Fixed annuities, on the other hand, are both safe and inexpensive.

There are two basic types of fixed annuities. One is a traditional or “CD-Type” annuity that simply pays a fixed rate for a fixed time period. For example, as of March, 2009 the best traditional fixed annuities were paying approximately 4% a year for three years and 5% a year for five years. While these are not high rates, they are substantially higher than most if not all CDs, money market or savings accounts, or Government bonds.

Another type of fixed annuity earns interest linked to various stock market indexes. These are called “fixed index annuities” or “equity index annuities.” With these annuities, you receive gains linked to stock market indexes, but your account never goes down. Of course, you do not receive all the gains from the stock market with no losses. This would indeed be “too good to be true.” In the financial world, if something sounds too good to be true, it is never true. Instead, there are “caps” on the amount you can earn in a fixed index annuity.

Fixed index annuities take many different forms, with different rates and caps, etc. A simple version would be one that pays up to 12% in interest if the stock market (the S&P 500 index of large U.S. stocks) goes up. If the index were to go up 10% in a year, you would make 10%. If it goes up 15%, you would make 12%, as 15% is above the cap of 12%. But if the stock market were to go down 20%, your account does not go down a penny. Therefore, with this annuity, you would always receive between 0–12 % each year.

At this time, we believe the best fixed index annuities are better choices than any other financial vehicles that have guaranteed principal. The best such annuity has an account (as of March, 09) that offers up to 4.5% a month if the S&P 500 stock market index goes up. This means it has a maximum potential gain of 54% in a single year (4.5% x 12), with no losses should the market go down. Of course, we are fairly confident the stock market is not going to make 4.5% every month in any year. But given how low the market is at this time, we believe this fixed annuity is indeed likely to make over 20% the first year the market recovers. On average, we expect these annuities to make 6-8%, which is a very good rate for any investment that has guaranteed principal.

However, starting at today’s low market, we could easily make substantially more, on average, over the next few years. This should compare quite favorably to the returns you are likely to receive from any other alternative that has guaranteed principal. Please note that there are a large and growing number of fixed index annuities on the market. They vary a huge amount in terms of their quality and rates, with the best having rates nearly twice as high as the average. (Many offer up-front bonuses, though these are rarely the best choice.) With so many different annuities available, you need to shop very carefully. Should you wish to receive quotes on the best annuities, please contact us at (925) 855-4300 to schedule an appointment.