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Should I use annuities as a temporary investment?

I invested in a four-year fixed annuity several years ago to allocate a percentage of my portfolio into a vehicle that was conservative. At the time, it was the safest, risk-free investment recommended by my investment adviser. The annuity is set at 4 percent annually. I am a long-term aggressive investor who makes about 12-15 trades a year. My retirement horizon is between 2-5 years away from now. Is this a safe strategy going forward?

Retirement, Investing, Asset Allocation, Choosing an Advisor
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July 2018

Chamberlain, Michael

Sacramento Santa Cruz Silicon Valley Davis, CA

Yes, fixed annuities can be a great option for the conservative portion of your portfolio for three reason:

  1. The rate of return can be higher than a bank account or short-term bond ladder etc.
  2. The interest is tax-deferred until you take it out of the annuity. In other words, if you are still working and most likely in a higher-income bracket than when you will be retired, so the interest that you would have paid in taxes for a bank account or other short-term investment, will stay in the annuity earning more interest.
  3. The account cannot go down in value like some bond funds.

But there are a few cations about annuities too.

  1. Almost all annuities pay the salesperson a commission. Some annuities pay more commission than others and how do you know you are getting the best annuity option for you or the annuity that pays the agent the most income?
  2. Associated with most annuities is a “guaranteed minimum interest rate” and a stated “current interest rate”. Some annuities have an artificial high first year rate and then drop low after that. To counter this trick, ask for a fixed rate for a set period of time.
  3. Look at surrender charges. These are fees that are deducted from the account if you close it prior to the end of the surrender period. The longer the surrender period, the higher the interest rate and sometimes the higher the commission.
  4. Look at the quality of the company. Lower quality insurance companies have to pay higher interest rates to counteract the higher likelihood that the insurance company cannot make good on its obligations.
  5. Sometimes the annuity does not work exactly as it is verbally presented. Index annuities have some of the highest commissions, have the most-harsh surrender charges and are hard to understand exactly how they work. The client hears the “4% return” and assumes it is 4% interest fixed every year and that is not the case.

At the current time, it would be hard to find a 4-year locked in interest rate from a quality company that would pay even 2%. If in fact you have an annuity that is truly fixed rate interest at 4% from an A rated insurance company, it would appear that your advisor did well for you. If on the other hand the company is B rated and it is not a fixed rate annuity but in fact an indexed annuity than it is debatable as to if the recommendation was correct.

July 2018
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July 2018