How Safe is a Fixed Annuity?
April 29, 2010 by Peter L. Heimdahl
Editor’s note: This testimonial from a satisfied annuity owner might be of use to you in your own annuity selling.
For years, I have sung the praises of fixed and indexed annuities, ignoring Wall Street financial “experts” who often belittle these products’ supposedly low returns.
Let’s compare some long-term financial results: for the 10-year period ending Oct. 10, 2008, $100,000 invested in a S&P 500 stock mutual fund would be worth $102,159.* A fixed annuity earning an average of 4.5% a year (a conservative assumption; my personal annuity has averaged more than 5%) over the same time span would be worth $155,296.
It can be tempting to tell naysayers “I told you so.”
Not only can you come out far ahead financially with a fixed annuity, but you are spared the heart-stopping wild gyrations of the stock market. All you have to do is sit back and relax while your fixed annuity keeps forging ahead year after year.
This sounds impressive, but how safe is your money in an annuity?
First, it is important to understand that annuities are issued only by life insurance companies. The insurance company takes your annuity premium and reinvests it, producing a return that will allow a competitive interest rate to be paid to policyholders, plus a “spread” that will cover the company’s operating costs and profits.
Thus, the key to safety is knowing how these life insurance companies are reinvesting your premium money. Because of recent world events, I placed the company that issued my fixed annuity under a financial microscope.
I was pleased to find that the company, American Equity Investment Life, is operated by a cadre of rock-ribbed financial conservatives. After a meeting with their rather stern-faced investment team, I was impressed with their no-nonsense procedures and high investment standards.
Safety is the apparent overriding priority, and all investments are painstakingly scrutinized. The fact that they ignored the powerful siren call of sub-prime loans and other dicey investments shows admirable discipline. Most of American Equity’s investments are in high-quality bonds, of which 99% are investment grade and about 65% are U.S. government-backed. I was reassured to find nothing that worried me on their balance sheet.
Overall, I believe life insurance companies are in healthy financial shape and run conservatively. But you should check out the company you buy from to confirm this. And of course there is no such thing as 100% security in this world.
I’m sure you are familiar with a recent notorious event, where a giant financial conglomerate was bailed out by the U.S. government. However, it was the parent company’s reckless Wall Street misadventures that caused the problem. Their life insurance subsidiary is healthy, and even if the parent company had melted down, annuity holders would not have been affected.
Fortunately, insurance companies are regulated at the state level, and the regulations are strict — life insurance companies simply aren‘t allowed to engage in the kinds of mischief that brought banks and Wall Street firms to their knees.
Even in the highly unlikely event that your annuity company should fail, there is another safety net in place. State Guaranty Fund Associations, which operate somewhat like the FDIC, cover annuity policies for up to $250,000 (it can vary by state).
A reassuring word about indexed annuities: they are fixed annuities; they are appealing because they are jazzed up to give a greater upside potential than a plain fixed annuity, but with a floor — the principal cannot shrink. Even though it may be indexed to stocks, this is only a benchmark. Your money is not reinvested in stocks — it is invested in the same conservative manner as regular fixed annuity premiums.
For safety, why don’t you just put money in CDs at the bank? Annuities offer many advantages over CDs, a major one being that the interest earned is tax-deferred. Income taxes on CDs can eat you alive. With an annuity, using one of the many withdrawal options after retirement can greatly lower your eventual income tax bill.
For the record, I contribute as much as I can to my pre-tax 401(k) account. But most of my after-tax savings have gone into my fixed annuity, to my great benefit.
Yes, I have some anxiety-inducing stock funds in my 401(k) account. But thanks to my fixed annuity, which holds about one-third of my retirement assets, I have enough peace of mind to sleep at night.
*Source: Vanguard; assumes all dividends reinvested and a 0.15% expense ratio.