What is a Fixed Rate? Why 2015 Will Be A Big Year for Fixed Annuities

Fixed annuities will likely explode in popularity.
Fixed annuities will likely explode in popularity.

This year will be big for fixed annuities, according to financial experts.

But how an annuity works remains a mystery for many. AARP found that half of surveyed workers described themselves as “not too familiar” or “not at all familiar” with annuities — let alone the intricacies of different kinds of annuities and why a fixed annuity is different than any other.

An annuity, or insurance product that pays out income, allows you to make an investment in the annuity and then makes payments to you — giving you a dependable income stream during retirement.

In 2014, total annuity sales were expected to end up 3% to 5% above 2013 levels, according to a Insured Retirement Institute (IRI) 2014 report.

Interest rates directly impact both the costs and benefits of annuities.

Persistently low interest rates have a negative impact on the annuity industry, IRI explains, noting that lower interest rates require more of each premium dollar to be set aside to support the guarantee, leaving less to purchase the index options that provide the growth component.

Despite persistently low interest rates, several factors are supporting annuities’ growing use.

“Investor desire for guaranteed income, an aging population, increased longevity, increased interest rates, and market volatility” are all factors that contribute to why demand for annuities will persist, IRI says.

Different annuity options– What is Fixed Rate? Variable?

There are many different types of annuities. Three main types of annuities are variable, fixed and indexed. These annuities differ in the way they generate earnings, and in the amount of risk involved.

Variable: The amount of income you receive from a variable annuity can depend on underlying investments. So if the investments behind the annuity are doing well one month, you would receive more money that month than you would when the investments behind the annuity are doing poorly.

Fixed: Fixed annuities guarantee a certain base of income per month. The amount of income you receive every month from a fixed annuity is exactly the same no matter what. In addition, these periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

Indexed: An indexed annuity is a fixed annuity. The insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

“With an immediate annuity, your income payments start right away (or within one year),” explains Lafayette Life Insurance Company. “A deferred annuity has two phases: the accumulation phase, where you let your money grow, and the payout phase, where you begin to receive scheduled payments.”

Treasury changes encourage annuities

“The final regulations from the IRS on qualified longevity annuity contracts within retirement

plans have helped bring some attention to fixed annuity products and guaranteed income throughout retirement,” says Erik O. Klumpp, founder and president at Rochester Hills, Mich.-based Chessie Advisors, LLC.

Last year, the Treasury made changes to encourage annuities in retirement 401(k) plans. The new guidance makes it easier for workers to use part of the assets within their (401) k or IRA plans to purchase a deferred life annuity at a relatively low cost.

This type of deferred life annuity, called a longevity annuity, is much less expensive than an annuity where monthly payments start at retirement, says Robert Pozen, senior lecturer at Harvard Business School and non-resident senior economic studies fellow at The Brookings Institution in a recent article published by The Brookings Institution.

A longevity annuity should appeal to workers who believe they have enough retirement savings to last for one or two decades, and want to ensure an additional revenue stream beyond those years, he says.

Fixed annuities provide reliable revenue

“While 2013 and 2014 have not been significant growth years for the [annuities] industry as a whole, sales began to shift away from variable annuities and toward fixed products, with fixed indexed annuities and immediate and deferred income annuities showing especially strong growth,” IRI says in its 2014 report, noting that fixed annuity sales were up 25.6% as of the third quarter year-to-date in 2014 versus the prior year-to-date period.

But why are fixed annuities becoming so popular?

“As more and more baby boomers enter retirement, they may be looking to protect some of their investments from stock market risk and provide steady income, which a fixed annuity can help provide,” Klumpp says.

While variable annuity sales tend to do well in rising markets and fixed annuity sales lag, “customers may be looking at locking in some of the gains they’ve made over the past few years and making a shift to a fixed annuity with a guaranteed payout in retirement,” Klumpp says.

Ultimately, it’s always important to meet with a financial planner to make sure you fully understand the product and type of investment you are making.

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