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Keeping too much in cash puts you behind, and you may not catch up.
If you’re considering buying a fixed-rate annuity, which acts much like a tax-deferred version of a bank CD, should you wait until rates move higher?
First, it’s impossible to know when or if annuity rates will move up. The rate you get today may be as good as or better than the one you’ll get if you wait.
Second, even if you do luck out and rates rise substantially, you’ll almost certainly come out behind. While you’re waiting, you’ll earn almost nothing in a money market fund or a bank savings account and only a bit more in a “high-yield” account. Depending on how long you wait, it may be nearly impossible to catch up later.
Despite recent declines, fixed-rate annuities still pay more than you might think. As of April 2021, you can earn up to 2.90% a year on a five-year fixed-rate annuity and up to 2.25% on a three-year contract, according to AnnuityAdvantage’s online annuity rate database. The top rate for a five-year CD is 1.15% and 0.95% for a three-year CD, according to Bankrate.
How delaying puts you behind
Let’s say you put $100,000 into a five-year annuity currently paying 2.90%. It will be worth $115,366 five years from now if you don't take withdrawals and let your interest compound.
Suppose you instead put your money in a money market account yielding 0.20% and wait for higher rates. After two years you’d be behind the annuity by $5,484. To catch up and achieve the same value at the end of five years, you’d need to find a three-year annuity paying 4.72%, which seems highly unlikely.
And this calculation doesn’t include the benefit of the annuity’s tax deferral.
Playing the interest-rate waiting game is a form of passive gambling, and it’s a bet you’re almost guaranteed to lose. But unlike Las Vegas, there’s no ‘house’ taking the money—you never earned the interest in the first place.
It doesn’t make financial sense to avoid longer-term fixed annuities when interest earnings can be dramatically improved over cash equivalents.
If you’re uncomfortable about locking in today’s rates, consider a strategy of half now and half later. Allocate today half of the funds you’re considering for fixed-rate annuities. Set aside the remaining half in case rates increase soon.
Emotions too often drive financial decisions. But the numbers show it’s better to commit to a fixed-rate annuity today rather than wait for some potential higher future interest rate that may never come.
Fixed annuity pros and cons
Before you invest in an annuity, be aware of the pros and cons.
Benefits include guaranteed set rates, unlimited tax-deferral until you take money out, lower taxes on Social Security benefits for some retirees, and some liquidity. Most fixed-rate annuities let you withdraw interest or up to 10 percent of the value annually without penalty. Larger amounts are subject to a surrender charge if withdrawn before the surrender period is over.
Another drawback is that the IRS penalizes annuity withdrawals before age 59½. So, don’t use an annuity for any money you’ll need before 59½. You’ll also have to pay income taxes on any interest withdrawn unless the annuity is in a Roth IRA.
Unlike bank CDs, annuities aren’t insured by the FDIC. But they are considered quite safe. Fixed annuities are guaranteed by life insurance companies, which are strictly regulated by the states to ensure solvency. And fixed annuities are also protected by state guaranty associations up to certain limits.
Annuity expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and immediate income annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. He writes on retirement income and annuities regularly for several leading financial websites.
A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com or by calling (800) 239-0356.