The Risk Factors of Fixed Annuities
With the exception perhaps of the Treasury bonds, no investment is risk-free. Among fixed annuities, sometimes they may offer a little higher than average return as compared to other fixed investments. After all, these bonds that underlay many of these investments are guaranteed by the federal government and are considered to have less risk than other bonds. In financial investments, instruments that can potentially give the highest yields are probably those that carry the highest risks.
Fixed annuities offer investors stable returns at a low risk. However, because the risk is low, the expected returns may also be low. You may opt for instruments with higher potential returns. There are other options but your risk exposure will likewise increase.
For example, investing in mutual funds may yield higher returns. However, unlike in a fixed annuity contract, the returns are not guaranteed. If the fund you invested on fares badly in the market, you incur losses instead of gaining steady profit. This is why when the investment climate is turbulent or becomes unpredictable, many investors slow down and put more money on these low risk plans as opposed to other financial instruments because this is a safer way to receive fixed income. But regardless of the market situation, many investors include them in their portfolio for stability.
Perhaps one of the biggest risks to a fixed annuity is the exposure to default in payment. A default occurs when the insurer or the responsible financial institution fails to pay the annuitant the amounts specified in the contract, whether due to bankruptcy or for any other reason. In the event of a default, losses may be considerable depending on how much of the entire account was defaulted. It is recommended that you buy only from reputable companies to minimize this risk. You may encounter some companies that will offer very lucrative and enticing packages but if they do not have a good track record to show, immediately say no.
Another factor to consider when investing on fixed annuities for the long term is inflation. Because of the “fixed” nature of this policy, amounts to be paid out to you, say 10 years from now is already pre-determined. There is no guarantee that the fixed amount you will receive then will have the same purchasing power as the money you are investing today. Depending on the actual inflation rate that will prevail for the next 10 years, the amount you will receive may have either more or less.
To address the concern on rising inflation rates, some insurance companies are now offering a new rider, the Cost of Living Adjustment (COLA). This provision will cover for the additional payouts based on inflation rates. The COLA may be paid for as part of the annuity contract or may be purchased separately.
When investing, it is always a very good strategy to get as much information on various products first. Spend time understanding the various features and comparing them before deciding and making a commitment. Know all the advantages and be wary of the risks involved. You owe it to yourself to make the wisest choice of investment possible because you worked hard for that money.
Annuities are best suited for long term investors. Any withdrawal prior to age 59 ½ is subject to a 10% tax penalty as well as regular income tax. Annuities often also have a surrender schedule, meaning that withdrawals may be subject to a penalty by the insurance company if not left in for a predetermined amount of time. Any guarantees on principal invested are based upon the claims paying ability of the underlying insurance company.