Increasing interest rates are good for some investments, but those who invest in bonds are looking for alternatives as interest rates increase. In Marketwatch’s “Fixed-index annuities as bonds alternatives?,” Robert Klein talks about how an increase in interest rates almost always means a decrease in bond prices. The 10-year U.S. Treasury index level of 2.83% was a 52 week high and an 84% increase from last year at this time. The U.S. Aggregate Bond Trust had large increases two years in a row, but is down more than 3% this year. Dividend stocks are an alternate way to offer income, but some investors see the increased equity risk to be worse than staying in the bonds markets with their money. This has brought up the alternative of using fixed indexed annuities to keep your fixed income while remaining protected from declines in the bond and equity markets.
Fixed indexed annuities give you a minimum guaranteed interest rate, but also offer the potential for increases based on the participating stock market index. Earnings grow tax-deferred if you do not purchase the annuity with retirement plan money. You can create a lifetime stream of income by adding on an income rider or opting for a minimum guaranteed withdrawal benefit. You can buy an indexed annuity with a single premium or pay in multiple payments with a flexible premium option. Either way, some of your money is allocated to a fixed fund and the rest goes into an indexing strategy. Based on one or more stock market indexes, you have the potential to gain money in that part of your annuity fund. There are two big differences between this type of product and other investments. Your money is protected from market declines, but your gains will be capped at a predetermined percentage.
There are many advantages when you choose a fixed indexed annuity over a bond, not the least of which is the protection you get from declines in the market. You also have the potential to earn money on market gains and those earnings are tax-deferred when your fixed indexed annuity is purchased with non-retirement plan funds. You eliminate the risk of bond default and have the option of lifetime income guarantees with an income rider or GMWB. Managing your investment is simpler and the fees for investment management are eliminated for the portion of your funds in fixed indexed annuities.
Certainly these products are not perfect and there are disadvantages depending on your personal financial plan. Fixed indexed annuities are a longer term investment than bonds because there are usually surrender charges if you take your money out before 5 or 10 years, although that might be changing soon. Longer terms are available and often come with higher cap rates or premium bonuses. If you don’t need the money right away, the long term commitment is not a problem and you can benefit from the increasing caps. It’s important to pick an insurance company with strong financial strength ratings since your lifetime income guarantees are based on their claims paying ability, although annuities have a good history of being paid out. Annuitizing fixed indexed annuities offers a better tax treatment than taking distributions from an income rider, which is something to consider for the future.
With all of their advantages, fixed indexed annuities may be a good alternative to bond investments, especially as interest rates continue to rise. There are important things to consider, but the guaranteed income, market downside protections and upside potential are worth a consideration for investors today.
Written by Rachel Summit