Do you have a variable annuity and are you looking for alternatives to it? Not sure about what options might make sense for your situation?
Many people buy annuities for different retirement goals, but variable annuities tend to be bought more than other types of annuities. However, this is likely to change in the near future. What is driving this shift is that people are on the lookout for alternatives to variable annuities.
Why? Variable annuities offer the most growth potential of all annuities. But they also have the most exposure to market risk.
What’s more, while this isn’t universally true for all of them, many variable annuities are also fee-heavy and expense-heavy.
According to the SEC, just one annual charge for life insurers managing longevity risk – called a mortality and expense charge – can add up to 1.25% per year in variable annuity contracts. Other research by groups like Morningstar has also found that cumulative fees and expenses in a variable annuity can be in excess of 3 percent.
Depending on their needs, people may be interested in alternatives ranging from annuity contracts with less market risk to financial vehicles that aren’t even annuities at all.
What Are the Alternatives to Variable Annuities?
There are a variety of annuities available to consumers that aren’t variable annuity contracts per se: fixed annuities, multi-year guarantee annuities, fixed index annuities, and immediate annuities.
You also have variable annuity alternatives that encompass non-annuity options, as well. On the whole, a more comprehensive menu of substitute choices can include:
- Bank savings accounts
- Money market funds
- Credit union or bank certificates of deposit
- Immediate and fixed-type annuities
- Treasury securities
- U.S. government bonds
- Investment-grade & junk bonds
- Municipal bonds
- Bond funds
- Bond ETFs
- Stock options
- Managed accounts
- Mutual funds
- ETFs (exchange traded funds)
- REITs (real estate investment trusts)
Of this menu of variable annuity alternatives, only annuity contracts can pay you a truly guaranteed income for life. They can also balance risk and gaps in your retirement plan with other contractual guarantees, including:
- Guarantees for principal protection,
- Guarantees for growth,
- Guarantees for death benefit payouts,
- Guarantees for impairment or long-term care funding, and more.
For the rest of this article, we will focus on some annuity alternatives to their variable annuity cousins.
Immediate annuities are probably the simplest form of an annuity. Someone writes a check to the life insurance company. In exchange, they start to receive a stream of income immediately.
This type of annuity is a good fit for those needing guaranteed income right away. There is no growth in the contract per se.
You are annuitizing the lump sum of money that you paid into the contract, and in exchange, you will receive a lifetime income that is irreversible. You can’t take your money back as a lump-sum payment.
On the flip-side, the insurance company will pay you this guaranteed income for as long as you live.
Unlike an immediate annuity, a fixed annuity can pay you income at a later date than right away. It has a “waiting period” before you might turn on income, known more formally as an accumulation period.
In a fixed annuity, your money will earn a guaranteed interest rate for a certain period. This type of annuity tends to have low or even no fees. The fees are built into the contract design, so the interest rate that you are guaranteed incorporates this.
The rates of a fixed annuity tend to be more competitive than bank CDs or other fixed-interest instruments. However, they typically earn less interest than other types of annuities.
Insofar as contractual promises by the insurer, a fixed annuity can provide you with a number of guarantees: guaranteed income, guaranteed rates (as stated), and guaranteed protection from market risk.
Once the accumulation period for the annuity has been completed, you can turn on a guaranteed income if you so choose.
Multi-Year Guarantee Annuities
A multi-year guarantee annuity is also known as a MYGA or a MYGA annuity. It operates in much the same way as a fixed annuity does.
A multi-year guarantee annuity contract will have the same interest rate guarantee as a traditional fixed annuity does. However, the MYGA’s period for guaranteed rates tends to be longer.
If you are shopping around for MYGA rates, you might have seen the interest rate given as a “guaranteed effective yield” or a “net yield.” Insurance companies sometimes present this as a “net yield” of an initial high teaser interest rate and lower rates for the remaining term of the guaranteed period. So it’s a “net rate” of those rates being offered and guaranteed.
Just like with a fixed annuity, a MYGA is a long-term commitment for your retirement money. It tends to have higher interest rates than a fixed annuity, since the term is longer. In exchange, the liquidity with free withdrawals isn’t as flexible in a MYGA annuity as it might be in other fixed-type annuities.
With a MYGA, the guaranteed period for earning interest often lasts two to ten years. The longer that the term goes for, the higher the interest rate generally is. A MYGA can also offer you contractual guarantees for protected retirement income and protection from market risk, just like other fixed-type annuities do.
Fixed Indexed Annuities
A fixed index annuity is a step up from MYGAs and traditional fixed annuities. You still enjoy contractual guarantees with this type of annuity, such as principal protection and an assured income for life. However, the interest that your money earns isn’t guaranteed.
The growth potential of a fixed index annuity is tied to an underlying financial benchmark, like the S&P 500 price index. The interest that is credited is based on what this underlying benchmark does.
When the index goes up for a certain period, your interest earnings are calculated based on a portion of that growth. What about when the index benchmark goes down? Then you are simply credited zero percent for that period. For that period, your original sum of money and your existing interest earnings are locked in.
The crediting period for determining your interest rate can vary, but many annuity owners choose options that track the index movements for a year. The choices for how long the crediting period lasts can go for two years or sometimes even longer. Your financial professional can go over all of these details and other information with you.
How Else Do Fixed Index Annuities Differ from Other Annuities?
Since the growth potential for your money in a fixed index annuity can vary, the interest rate isn’t guaranteed.
However, fixed indexed annuities have historically paid more interest than MYGAs and fixed annuities have. In fact, indexed annuities were originally introduced as an alternative in the 1990s for earning more interest than what bank CDs paid.
To that effect, fixed index annuities tend to have higher growth potential than other fixed-type annuities. But it isn’t guaranteed, meaning there is no “set” rate of interest that will be credited.
If you do want a guaranteed rate, most fixed index annuity contracts do have a fixed interest bucket alongside index-tied interest crediting buckets into which you can put money. But this bucket tends to pay less interest than fixed annuities or MYGAs do.
Many annuity owners use fixed index annuities for guaranteed income, as these contracts often let you have more control and access to your money while receiving a guaranteed income for life. You also benefit from guaranteed principal protection.
For these reasons and more, indexed annuities are one of the most popular annuity types. Millions of Americans use them for their growth potential while still enjoying safety of principal.
Which One is the Right Variable Annuity Alternative for You?
Ultimately, the right choice for determining an alternative to your variable annuity depends on your situation. Do you need guaranteed income right away? Then give immediate annuities a look.
Want a guaranteed interest rate, but don’t want to lock up your money for a long time? A traditional fixed annuity or a short-term MYGA annuity might be your answer.
How do you choose between these two options? If you might need some liquidity, a traditional fixed annuity might be able to give you that. If you want a higher guaranteed rate or you want a guaranteed rate for a longer timespan, then a MYGA annuity can provide you with those benefits.
Do you want some growth potential for your money, but still want to have your principal protected? If you are comfortable with not having a guaranteed interest rate, a fixed index annuity may be the solution.
Your Solution May Include Other Alternatives As Well
Of course, finding an alternative to a variable annuity might well take you beyond the universe of annuity choices, as well. In fact, this may be a likely outcome, given that an annuity is just one part of a well-balanced retirement plan.
Your financial professional can walk you through all of these options and find good solutions for your personal situation. Ask your financial advisor about fixed-type annuities as an alternative to variable annuities and what they can do for your retirement.
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