Fixed Annuities – Pros and Cons While fixed annuities are demonstrably superior to bank CD’s as safe, profitable and convenient savings vehicles, prudent consumers should educate themselves about fixed annuities’ pros and cons, after which they can shop for the fixed annuity that most meets their needs.

Surrender charge: The main objection most people have to fixed annuities is the surrender charge – the penalty paid on withdrawals before the maturity date. On a newly-purchased annuity, this charge can be significant – as much at ten percent of the amount being withdrawn. However, most fixed annuities provide for annual penalty-free withdrawals of up to ten percent. Thus, someone with a fixed annuity of $100,000 who withdraws $15,000 would pay the charge only on the amount by which the withdrawal exceeds ten percent of the annuity value – or $5,000. Most fixed annuities also permit additional early withdrawals, besides the annual penalty-free ten percent, for people with special circumstances, such as those receiving long-term care. Thus, it’s safe to say that consumers should only put long-term savings amounts into fixed annuities – money they don’t plan on needing during the term of the annuity. A good insurance company, moreover, will endeavor to make sure that the client has a good emergency fund (3 – 6 months expenses) in fairly liquid form outside the annuity.

It’s important to keep in mind that every single savings and investment vehicle has a surrender charge – indeed, every investment. All annuities are straightforward about it while other account types aren’t. Consider a checking account – with immediate, penalty-free liquidity, it’s most convenient. A checking account, however, usually pays no interest, or very low interest. The “surrender charge” paid for the convenience of total liquidity is the interest foregone. A CD actually has multiple surrender charges – the actual charge paid for withdrawing funds early (usually 3 – 6 months interest), the frequent requirement that the CD be totally liquidated even if the owner needs only a portion, increasing the penalty, the difference by which the annuity’s interest rate exceeds the CD’s, and the tax penalty (taxes on CD interest are due the year it’s credited). And the surrender charge on investments is the risk of losing some or all of the principal used to purchase the investment.

Fixed interest rate: The fixed interest rate can be considered either a benefit or a drawback of a fixed annuity, depending on economic circumstances. In a rising economy, at the point where prevailing rates exceed the annuity’s interest rate, it could be considered a drawback; however, in a declining economy, it’s a clear advantage for as long as prevailing rates are below the annuity’s rate. As recently as 2007, fixed annuities were being sold with an interest rate of eight percent, and those who purchased them then are very happy.

Tax treatment: The tax treatment of fixed annuities is also both a benefit and a drawback, depending on the circumstances. During the life of the annuity, when interest is credited to the annuity, it’s not taxable – it becomes taxable only when money is actually paid out to the owner. The deferral of taxes on interest allows the annuity to grow at a much faster rate, which is a very substantial benefit. The assumption is that the annuitant will be at a lower tax rate when funds are drawn out of the annuity, reducing the tax liability. However, when annuities are paid to beneficiaries because the owner has died, the interest earned is treated as ordinary income and taxed at that rate. Since many seniors use fixed annuities as savings vehicles to accumulate money to pass on to their heirs without the bother, delay and publicity of probate, they should consider at some point moving the bulk of their annuity savings to single-premium life insurance, the proceeds of which pass to the beneficiary completely tax-free and also avoid probate.

Other features and benefits of fixed annuities all provide advantages to the owner and cannot be reasonably considered “drawbacks:”

- The surrender charge declines over time, reducing the cost of withdrawals above the ten percent penalty-free annual entitlement

- Annuities may be converted, or “annuitized,” at any time, to a guaranteed income stream for life.

- Income from an annuitized annuity is considered retirement income and is usually exempt from judicial action.

- Funds in a fixed annuity are always accessible – the issuing company has no right to refuse to honor a withdrawal request.

- If the annuity owner dies, the annuity is paid over to the beneficiary without being included in the estate, without the delay of probate, and without the attendant publicity.