There are certain economic cycles that occur every few years which drive up the interest rates in fixed annuity accounts. We are in one of those cycles now. Savvy investors can lock in very high annuity rates (yields/returns) that did not exist only a year ago.
The most recent economic meltdown has many of us questioning the overall wisdom of stock and bond market investments. Consider in the last ten years, the overall markets have witnessed substantial losses – from the dot com bust to the current mortgage crisis and credit crunch. It seems to be one correction after another.
Banks have fared no better as institutions large and small issued loans to sub-prime borrowers and now are holding bad debt. The Federal Reserve has lowered interest rates several times in an attempt to unlock the credit markets, but that does not bode well for money market rates and certificate of deposit yields.
So why are fixed annuity rate so high? The reason is that their interest crediting is primarily tied to government treasuries and credit spreads. While treasury yields are on the low side, credit spreads have increased dramatically. When the two are combined, fixed accounts can yield well over 5.50% depending on the annuity term and deposit amount.
Credit spreads primarily affect corporate bonds. When credit markets are not functioning properly and there is fear of corporate default, it is simply more expensive to issue debt. Large companies in little danger of default must issue debt with higher yields to fund their daily obligations. Insurance companies purchase these bonds, package them with treasuries, and then issue high yielding annuity accounts. They do all of this while assuming most of the risk. And fixed annuity accounts are insured for the consumer up to certain state limits – usually $250,000 per contract in most states and up to $300,000 per household.
Thus, it is wise for consumers to consider a cd type fixed annuity account as a medium range or long term savings instrument. Typically, annuity terms will run between 2 to 10 years depending on the investor’s time horizon. If the interest is not withdrawn, then the gains will compound on a tax deferred basis. At the end of the term, the annuitant (owner of the annuity) can purchase a new policy or withdraw their funds in their entirety without penalty. The bottom line is annuities are a reprieve from low rates and market risk.