Are Fixed Annuities or Individual Bonds a Better Choice for Retirement Funds?, #107
Due to a recent rise in interest rates, annuities are experiencing record sales. This boom has listeners curious about whether to purchase hot ticket annuities or individual bonds. If you’re considering buying a fixed annuity, I want to give you the pros and cons of fixed income investments, as well as potential alternatives to help you make the best decision for your retirement portfolio.
You will want to hear this episode if you are interested in...
The pros and cons of fixed annuities [2:40]
Taking a look at fixed annuity alternatives [7:16]
Other ways to take advantage of rising interest rates [10:19]
Weighing the pros and cons
With record high inflation rates, the Federal Reserve is doing everything it can to lower inflation by raising interest rates. This increase has produced competitive yields for fixed annuities, with interest rates between three and four percent depending on the company you invest in and the amount. If you want to purchase an annuity, I believe that three-year fixed annuities are the best option. Why three years? The unpredictable nature of these rates makes short-term fixed income investments the safer bet because there’s no telling what the rates will be beyond a few years. A three-year fixed annuity is much more predictable and will help to ensure a competitive yield.
However, there are definitely some drawbacks to purchasing a fixed annuity. Anytime you buy an annuity, there is some type of commitment period for the investment. Meaning, that on a three-year fixed annuity your money will be tied for three years. If you want access to the principal before the commitment period is over, you would need to pay a penalty. Some annuities allow you to withdraw up to ten percent of the principal without issue. Anything above that will take money out of your pocket at a rate of seven to nine percent depending on the company. Then there is the nature of annuities themselves. These products are designed to benefit the insurance company over the investor. They take the money you invest in an annuity and invest it into something with a higher rate of return than your interest rate. They figure out how much money they need to invest in something to make a profit and pay you a lesser amount. If you decide to access the principal early, the company will have to sell off its investment as well. Any loss they incur on interest rates will then be passed to you.
Keep your options open
Just as rising interest rates allow you to get a more competitive return on fixed annuities, the same can be said for bond investments. When you buy corporate or U.S government bonds, you want to make sure the brokerage firm allows you to purchase individual bonds with your account. Additionally, the yield on a two-year U.S. government bond has risen to 3.2 percent. That means you can get a similar yield to a fixed annuity with a shorter commitment period. There is also very little risk with treasury bonds because the U.S government would have to default into bankruptcy for someone to not get their money back.
Liquidity is another huge advantage to U.S. Treasury investments. Investors can sell these bonds at any time without penalty. The only downside is that market value adjustments can cause you to sell these bonds at a loss if interest rates have risen since the purchase date because the price of the bond would go down in value. Investors can also look to corporate bonds as a potential investment option with higher yields. However, with the greater reward comes the greater risk of investing in companies subject to market volatility. For more information on fixed annuities and other investment opportunities, listen to this episode!
Resources Mentioned
Investors Pour Cash Into Higher-Yielding Fixed Annuities (WSJ Article)