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Interest rates on the safest investments like savings accounts, bank CDs, money market accounts, and Treasury bonds are very low these days. If you factor in even small inflation, you lose money on it, even before you pay income tax.
What are the best alternatives for people looking for a higher guaranteed interest rate?
This is a big problem for people in their 50s and older who don’t want to take too much risk in the stock market, and for retirees who rely on their savings to generate income. Here are three good alternatives, all classified as fixed annuities, but different from each other.
Fixed rate annuities pay higher guaranteed rates
A fixed rate annuity, also called a multi-year guaranteed annuity, is a lot like a bank CD. Both guarantee the interest rate for a specific period. But there are a few key differences.
One is that today, fixed rate annuities have much higher rates than comparable CDs. From early February 2021, you can earn up to 3.00% per year on a five-year flat rate annuity and up to 2.40% on a three-year contract, according to the online database AnnuityAdvantage.
According to Bankrate, the maximum rate for a five-year CD is 1.00% and 0.85% for a three-year CD. Annuity rates are still high, but continue to decline. If you are interested in a fixed annuity acting now, you are likely to get a higher rate today than next month or later.
Another difference is that with an annuity, interest is deferred until you withdraw it. You can either receive interest annually and pay taxes, or add it to the annuity and thus defer taxes.
There is one important nuance. If you withdraw money from any type of annuity before the age of 59½, you will usually have to pay the IRS a 10% penalty on the interest income you withdrawn, plus normal income tax. If you are much younger than 59.5 years old, do not buy an annuity unless you are sure that you do not need to borrow money before that age.
The issuing insurance company guarantees annuities of all types. They are not FDIC insured. However, associations that guarantee government rents do provide a solid additional layer of protection. Fixed annuities are suitable for both unqualified accounts (savings that would otherwise be taxable) as well as qualified retirement plans like the IRA, Roth IRA, and 401 (k) and 403 (b) plans.
Fixed Indexed Annuities Offer Potentially Higher Long-Term Returns
Loan interest on indexed annuities is based on the growth of a market index such as the S&P 500. Thus, the interest rate fluctuates annually. In a few years, you will be making a profit. In difficult years, you will not lose anything, but you will not earn anything.
So, for example, in the first year you can earn 9%, 0% in the second year, 4% in the third year, and so on. If you accept the risk of earning nothing for several years, in the long run, you will most likely receive more interest than with a fixed annual rate.
Indexed annuities are for people who want to save for the long term and limit their risk without hindering growth. They are usually not suitable for people who need a stable income right away to cover their living expenses.
Think of them as a separate third class in terms of asset allocation: fixed income (CDs, bonds, and other fixed annuities); stocks (stocks and stock funds); and indexed annuities.
Since there are different lending methodologies and limits, some research needs to be done to compare and determine which indexed annuity is best for you. Work with an annuity professional who has the necessary resources and training to help you through the process.
Profitable annuities provide much more guaranteed income
If you are looking for the most guaranteed income, here is an alternative you might not have thought of: an income annuity. Unlike fixed rate annuities or fixed indexed annuities, once purchased, annual annuities do not have a funded value, so they do not pay the stated interest rate. You pay a lump sum or series of deposits to the insurer, which guarantees an income stream.
You choose how long the payments will last for example, you can choose ten years. However, most people opt for a life annuity that will pay you (and possibly your spouse) a guaranteed monthly income no matter how long you live.