Since the financial meltdown of 2008, deferred annuity sales have surged to new highs led by variable annuities, followed by indexed annuities. Even fixed annuity sales, which have trailed the other two due to low fixed yields, have seen resurgence. All three types of deferred annuities are recipients of the huge outflows of money from mutual funds, stocks, and, more recently, bonds looking for more growth and income guarantees. The massive inflows into annuities has spurred the growth of new and more competitive products making it even more challenging to find the best deferred annuities.

What’s the Big Attraction?

Tax Deferral

For several decades, deferred annuities have always held great appeal for investors looking for ways to minimize their taxes while accumulating for long term needs such as retirement. The returns on deferred annuities are not currently taxed which allows them to grow more quickly than if they were taxed each year. For variable annuities with their potential for market type returns that can mean a significant increase in accumulated funds over the long term. The tax deferral available with fixed annuities provides CD investors with a way to earn safe returns without the encumbrance of taxes.

Minimum Guarantees

Perhaps the larger attraction these days are the minimum guarantees available in deferred annuities. Shell shocked investors who saw their retirement savings account decimated in the last market crash are increasingly more concerned with the return of their capital than the return on their capital. Deferred annuities with minimum guaranteed return features or options provide investors with a measure of both. Fixed and indexed annuities include a floor rate that is credited no matter how low yields or market returns fall. More and more variable annuity products offer a minimum return option that, although it comes with an additional cost, gives investors the peace-of-mind knowing that they will always generate a positive return even in down markets.

Income Guarantees

Forward thinking investors look to the minimum income guarantees that deferred annuities offer when the time comes to convert their account values into a stream of income. The distribution phase of deferred annuities give investors the option of taking their payments over a specific period of time, or for their lifetime. If the lifetime option is chosen, the payments are guaranteed to continue even if investors live beyond their normal life expectancy. With the fear of outliving their income sources increasing along with their expanding life expectancies, retirees are looking at deferred annuities as “longevity insurance”.

Narrowing the Choices

With these key feature common to all deferred annuities, the task of finding the best can be all the more daunting. However, by applying some essential criteria, there are a few ways to separate the best from the rest.

Find Your Type

We’ve discussed three primary types of deferred annuities: variable, indexed and fixed. The key differentiator between the three is the way the rate of return is determined.
Variable annuities generate returns based on investment performance of separate accounts consisting of stock or bond portfolios. Similar to mutual funds, these accounts enable investors to invest for greater returns through professionally managed portfolios. As with mutual funds, the rewards are generally commensurate with the risks. So, variable annuities are more suited for investors who understand mutual funds investing and the risks associated with them.

Indexed annuities generate their returns through participation in the percentage gain of a major stock index, such as the S & P 500. If the index gains 20%, a portion of that return, after a participation rate and a rate cap is applied, is credited to the annuity account. Participation rates vary as do cap rates, so the higher each of these rates are, the higher the yield that is credited. Indexed annuity investors are willing to give up a portion of the index gain in return for protection against a decline in the index. Even in market declines, indexed annuity accounts are credited with a minimum rate of return. Because of this added protection, indexed annuities are suitable for investors of all risk tolerances.
Fixed annuities generate a fixed yield, often guaranteed for a certain period of time. The yields are based on the yields generated from the investment account of the life insurance company, so they tend to be higher than the yields on equivalent investments such as CDs. Fixed annuities are best suited for investors who seek the greatest amount of stability and predictability.

Choosing the best deferred annuity from among the three primary types is really a function of your own investment preferences and tolerance for risk. The best deferred annuity strategy might be to create a portfolio consisting of all three which would provide upside potential with optimum stability over the long term.

Comparing the Best

Once you’ve determined which type of deferred annuity is most suited for you, it would be important to narrow your choices even further in order so that you can make some straight across comparisons between the products. When prospective annuity buyers learn that there are dozens of life insurance companies offering hundreds of annuity products, through many different distribution channels, they often become discouraged and frustrated. It’s nearly impossible to conduct an effective comparison in a timely manner.
Finding the best deferred annuity can be made much simpler by narrowing the field of annuity providers to the very best companies. In the case of annuities, the best companies are defined by their financial condition, which, when rated by the independent rating firms, indicate their ability to fulfill their financial obligations in the worst of economies.

Companies rated “A” or higher are considered the best in that respect. With several dozen companies rated “A” you still have a range of competition that will produce the best rate of return, the most reasonable expenses, and the highest rate guarantees. But, more importantly, they provide the assurance that your funds are backed by best companies in the industry.

People considering annuities as a long term investment must be able to choose from several different types to find the one that best suits their own financial profile. While annuities of all types share many common features and characteristics, such as tax deferral, withdrawal provisions, guaranteed death benefits, and guaranteed income, they differ greatly in the way they generate returns for investors, from fixed yields to unlimited returns from stock and bond investment accounts. As with any investment choice investors make, the decision must be based largely on their own objectives, priorities and tolerance for risk. The same criteria should be applied when considering fixed vs variable annuities.

What They Have in Common

Fixed and variable annuities share many of the features and characteristics that make all annuities unique as investment vehicles. They both have accumulation accounts that allow for the earnings to grow tax deferred. They both allow for withdrawals to be taken without charge as long as they don’t exceed 10% of the account value in any year. They both provide a guaranteed death benefit and they both guarantee a lifetime of income. They each include a minimum rate guarantee, although, with a fixed annuity the guarantee is a part of the standard contract, whereas, with variable annuities, it must be selected and paid for as a separate option if it is available.

The Big Difference

The primary difference between the two types of annuities lies in the way the rates of return are generated for the accumulation accounts. It is this distinction which places them at opposite ends of the investment risk and reward spectrum separating their compatibility for risk-adverse and risk-oriented investors.

Fixed Annuity Returns

The rate of return on fixed annuities is determined by yield generated on investments in the general account of the life insurance company. Investor deposits are invested in a portfolio, consisting of yield bearing instruments such as government and corporate bonds. The yield that is credited to annuity accounts is a portion of the yield the insurance company manages to generate on its portfolio.

Most fixed annuities offer a rate guarantee that locks in the rate for a period of time, from one to 10 years. Generally, the longer the rate guarantee, the higher the initial rate. The length of the rate guarantee is typically tied to the length of the surrender period in which withdrawals that exceed 10% are charged a surrender fee.

At the end of the guarantee period, the rate is adjusted to reflect the current investment experience of the general account, or some predetermined adjustment formula. The minimum rate guarantee included in fixed annuity contracts ensures that the adjusted rate won’t fall below a floor rate.

Variable Annuity Returns

The biggest difference with variable annuities is that their accumulation accounts are separate from the general account of the life insurer. These separate accounts are set up much like mutual funds within a retirement plan, wherein investors can select from a family of accounts to create a diversified portfolio of stocks, bonds, fixed investments, and real estate funds. The separate accounts, managed by investment managers, generate rates of return based on the performance of the underlying portfolio of investments.

While the returns are unlimited on the upside, so are the risks on the downside. As with mutual fund investments, investors are able to allocate their funds among different types of stock and bond accounts to create a diversified and balance portfolio that can stabilize the rate of return and reduce risk exposure. Investors can transfer between investment accounts so that they can maintain the balance of investments appropriate for their investment objectives and risk tolerance.

Although variable annuities don’t include a minimum rate guarantee in their contracts, they do offer investors two forms of principal security. The first is through a guaranteed death benefit, which ensures that the investor’s beneficiary receives no less than the investor’s original investment as a death benefit. Many contracts also provide a ratcheting mechanism that ratchets up the principal at various times to include gains made in the account, so once the gains are achieved, the principal, or basis in the account will increase.

Additionally, some variable annuity contracts include an option to purchase a minimum rate guarantee, so that, in the event of a decline in portfolio value, the separate accounts will still be credited with a positive rate of return. There is a charge for this option, but for many investors, it’s an insurance premium worth paying.

Will it be Fixed or Variable

With an understanding of the main distinguishing feature of fixed and variable annuities, most investors will line up behind one or the other based on their individual risk-reward profile. Investors who understand market risk and the basic investment premise that higher rewards come with a commensurate amount of risk will consider variable annuities, while, investors who want to avoid risk at all cost, and are willing to accept a lower return to do so, will consider fixed annuities.

It Doesn’t Have to be ‘Either-Or’

One of the lessons learned from many of the pre-retirees who are finding that their accumulated retirement savings have fallen short of their expectations is that the need for a growth element in a retirement portfolio doesn’t go away. Retirement incomes that must last a lifetime need to be able to keep up with the rate of inflation, and retirement savings need continued growth throughout the accumulation years. For most investors, accumulating the funds needed for a secure retirement requires that a significant portion of their assets continue to work harder in growth oriented investments.

A combined fixed and variable annuity strategy can produce the upside returns needed for continued growth in retirement savings as well as stability and predictability. And, when the accumulation phase gives way to the income phase, the variable annuity can generate an income that increases over time to protect purchasing power while the fixed annuity provides the security of an income safety net.

The financial meltdown of 2008 launched a flight to safety that saw billions of dollars move from plummeting mutual funds into safe, fixed yield investments such as CD’s and annuities. Investors who saw their 401(k) plans cut in half in just a few months quickly turned to wealth preservation vehicles in order to protect their dwindling assets. Many of these investors discovering wealth protection virtues of annuities for the first time found themselves faced with two different types of fixed yield annuities and quickly had to learn the differences between fixed vs indexed annuities.

What’s to Compare?

Fixed and indexed annuities have more similarities than differences. They both credit a fixed yield to the annuity accounts. They both guarantee a minimum rate of return. They both allow interest earnings to accumulate tax deferred. They both allow investors access to funds through a withdrawal provision. They both offer a death benefit guarantee, and they are both convertible into an income annuity that guarantees a lifetime of income.

There is one primary difference, but it is significant, and that is how the fixed yield is determined. While the yields are fixed for both, a fixed annuity credits a yield that is generated from the investment performance of the life insurer’s general account, and the yield of an indexed annuity is generated from the percentage gain of a stock index. Because life insurer’s general account is invested interest bearing bonds, the resulting yield more closely mirrors those that are available in other fixed yield instruments such as CDs. Since the yield of an indexed annuity is derived from a stock index, it has the potential of exceeding the yield of fixed annuities.

Fixed Annuity Yields

The rates on fixed annuities are generated from the overall yield that life insurers earn on their own investment portfolio which consists of high quality corporate and government bonds of varying maturities. The rate is guaranteed for a specific length of time, from one to ten years, after which it is adjusted based on prevailing rates. But the new rate can never be adjusted lower than the minimum rate guaranteed in the contract. Because of this, fixed annuities provide the ultimate in predictability along with the assurance that the principal is secure.

Indexed Annuity Yields

The higher yield potential of indexed annuities brings with it an added layer of complexity due to the mechanisms employed to generate the yield. As previously indicated, indexed annuity yields are derived from the percentage gains of a stock index such as the S & P 500. If the index experiences a gain from one year to the next, the annuity account is credited with a portion of the gain. The other portion is retained by the life insurer as a “premium” for providing downside protection, because, even if the index experiences a decline, the annuity account is still credited with a minimum rate of return.

The mechanics of determining the indexed annuity yield are a little more involved. First, a participation rate is applied to the gain to determine the gross yield to be credited. For example, a participation rate of 80% applied to a 20% gain in the index would mean that 16% would be credited to the account. But, that is before the rate cap is applied. Each contract specifies a maximum rate that can be credited, so if the rate is capped at 8%, then, using the same example, 8% is credited to the account instead of 16%. Essentially, the market protection provided by the life insurer cost, in this case, 12% of the gain, which may seem like a hefty price, except to those investors who have incurred the wrath of major market declines.

Participation rates and rate caps vary widely from one product to the next, so it would be important to compare them to see which product can generate optimal yields from gains in the stock index. Just as fixed annuities offer a rate guarantee for a specific period of time, indexed annuities offer a guaranteed participation rate for a period of time. A high participation rate may turn out to be a way to lure you in, only to have it drop significantly in a subsequent year.
Indexed annuities provide an extra layer of protection by ratcheting up the principal, or basis, each year to include the prior year’s gain. This annual reset ensures that the annuity account will never lose value.

Another key difference is in the surrender provisions. Both types of annuities allow for one annual withdrawal during the surrender period that does not exceed 10% of the annuity balance. Excess withdrawals are charged a surrender fee which can be high in the beginning of the contract and then gradually declines to zero over the surrender period. Indexed annuities tend to have longer surrender periods (up to 15 years) and higher initial surrender fees (up to 15%). Again, it may be considered the high cost of downside market protection provided by the life insurer.

A Little Education can Yield Higher Returns

From an investor’s perspective, fixed and indexed annuities both offer a high degree of safety and predictability. While indexed annuities have the potential of generating higher yields than fixed annuities, their complexity may be too much for some people. Some investors who are risk adverse are also adverse to complicated investment products, so even the prospect of earning a few more percentage points on their yield, may not seem worth the trouble of understanding how indexed annuities work. But, for those who are willing to understand the mechanics of indexed annuity yields, those additional percentage points of yield can make a significant difference in long term accumulation.

Due, in large part, to stock market volatility and the continued uncertainty of the economy, annuity sales are seeing resurgence as more people shift towards a “capital preservation” mentality. A good portion of the outflows from stock and bond mutual funds have been finding their way into fixed annuities as havens from the chaos and unpredictability of the financial markets. Many people are looking at fixed annuities for the first time, so this explanation of how they work is very timely.

Fixed Annuities from the Inside

Fixed annuities are often compared to bank CDs if only because they both offer a fixed yield with the promise of safety of principal. Fixed annuities are quite a bit different than CDs in just about all aspects including how they generate their fixed rate and how they protect your principal.
Fixed annuities are contracts issued by life insurance companies to individuals looking for guaranteed rates of return without any risk to principal. Because they are, in essence, insurance contracts, they enjoy some of the same tax benefits of life insurance policies, such as tax deferred growth of earnings. Taxes are eventually paid when the earnings are withdrawn.

Competitive Fixed Yields

The rates on fixed annuities are derived from the yield that the life insurance company generates from its investment portfolio which is invested primarily in high quality corporate and government bonds. A portion of its yield is credited to the annuity account as a guaranteed fixed rate. You can select a guarantee period from one year to 10 years, with the longer periods typically credited with higher rates. Many fixed annuities offer a premium bonus for larger deposits of $50,000 or $100,000. The bonus rate, which could be an additional percentage point, is usually paid on the first year of the deposit.

Guaranteed Minimum Rates

Once the initial guarantee period expires, the rate is adjusted based on a specified formula, or the prevailing yield earned in the insurer’s investment account. As a measure of protection against declining interest rates, fixed annuity contracts include a minimum rate guarantee.

Tax Deferred Growth

We did mention the tax deferral aspect of fixed annuities, which, for people in the higher tax brackets, can make a significant difference in the amount accumulated over time. If an investor who pays taxes at a combined state and federal rate of 50% invests in a fixed annuity with a 4% yield, he or she would have to find a bank CD paying 6% to generate the same net return. When the earnings are withdrawn or taken as income, they are taxed as ordinary income.


To receive the maximum benefits that tax deferral provides, investors should be willing to commit their funds for the long term. But, because things do come up, annuity funds are accessible through annual withdrawals that can be made without charge as long as they don’t exceed 10% of the account balance. Most fixed annuities are structured with a surrender period in which a fee will be charged on excess withdrawals. The surrender periods generally last for seven to 12 years, and the fees, which can start as high as 12% decline each year until they vanish, after which funds are completely accessible without restriction. Any withdrawals made prior to the age of 59 ½ may be subject to an IRS penalty of 10%.

Guaranteed Income Payments

Withdrawals are one way to access annuity funds. Additionally, fixed annuities may be converted to an income annuity at any time. When this happens, the funds are irrevocably committed to the life insurer who promises to make a series of period payments for a specified period of time, or for the life of the annuitant.
If someone wanted to defer taxes further into the future, they could specify a period certain, such as five years, for annuity payments. Because each payment consists of both a return of principal and interest earned they are only partially taxed. Taxes will only be paid on the interest portion as they are received. Otherwise they could elect to receive annuity payments for life, which means that the life insurer is obligated to make payments for as long as the annuitant lives.

Safety of Principal

Fixed annuities are considered to be one of the safest investments available. The principal is backed by the assets of a life insurance company which must meet very stringent reserve requirements and financial standards. Unlike a bank, which only maintains a small fraction of its obligations in reserve, life insurance companies are required to maintain as much as 90% of their obligations as liquid reserves. Life insurers that meet the highest standards of financial integrity and strength are assigned the highest ratings by the independent rating agencies, such as A.M. Best, Standard & Poor’s and Moody’s. These companies can be expected to perform well and meet all of their obligations even in the worst of economic conditions.

Fixed Annuities as an Investment

For money that is looking for stability, predictability, and security, fixed annuities are ideal. Investors with a 10 to 20 year time horizon, who are risk adverse, or who want to begin allocating more of their assets towards capital preservation, would find annuities highly suitable.
While fixed annuities can help investors guard against market risk and taxation, they should really be considered as part of an overall investment strategy that includes some growth oriented investments. The risk of putting all of your eggs into the fixed annuity basket is that the rate of growth of fixed yields may not be sufficient to outpace the rate of inflation which can erode the value of your investment over time.
When included as part of an asset allocation strategy, fixed annuities can provide the portfolio with stability and predictability which should allow investors to take a little bit more risk with other parts of the portfolio.

A sound financial plan should always begin with the building of a solid, safety foundation for protection against the unexpected. It should include a 12 month emergency fund to protect against job loss or short term disabilities. It needs to have insurance protections against property loss, and, of course against the possibility of dying too soon. But what about the risk that more and more people are facing? That is the risk of living too long? For that reason, annuities should have a place in the safety foundation right alongside life insurance.

Life Cycle Protection

When it comes to life, no one can predict the future, but we do know that it is full of the unexpected, which is why it is important to build a safety foundation. No one expects to die too soon, but because the possibility exists, most responsible people insure their lives so that the capital will be available for their loved ones to carry on.

Conversely, living a long life is becoming more of an expectation, especially for the healthy among us. And, with life expectancies expanding each day, many people can see themselves living beyond the ages of their parents which are stretching well into the late seventies and early eighties. Yet, relatively few people are prepared, financially, to make their incomes stretch as far as their expected age. A recent survey of Baby Boomers reveals that less than 25% of them feel as though they have the means to live out their life expectancies.

Most people realize the life insurance is an essential component of their financial plan, because, if they or another breadwinner die too soon, they will not have accumulated the capital needed to provide for all of their families’ needs and obligation. And, for that, life insurance is the only viable tool. As people look out over their retirement time horizon and realize that they may not have the means to make their income last as long as they do, they will need to turn to annuities as the only viable tool that can ensure that their income will not run out.

Life Insurance to Create Capital

Life insurance is used as a creator of capital that becomes available at the moment the surviving family needs it most. It is most essential in the early stages of a family before enough time has passed to be able to accumulate their own savings. Annuities are a capital preserver which becomes increasingly important to people as they age. Without the ability to earn or accumulate more capital, it is vital that they be able to keep what they have and make it last.

Most people are aware of how life insurance works. In exchange for a premium, a life insurer promises to pay a death benefit to a named beneficiary. The amount of premium paid is based on the current age and health condition of the insured, and it is calculated to pay the risk costs of the death benefit that the insurer is obligated to pay.

Annuities to Preserve Capital

Annuities may be somewhat of a mystery to many people. As a form of insurance, they are also issued by life insurance companies. They are used when someone has a lump sum of capital they wish to preserve for future use, or as a source of income. In exchange for the lump sum of capital, the insurer promises to preserve the principal while making periodic payments for a term specified or for the life of the individual. The payments, consisting of both the principal and earned interest, can either be fixed, or tied to an inflation index, and they are calculated to be fully paid out by the end of the specified term of the individual’s life expectancy. Should the individual live beyond his or her life expectancy, the life insurer is obligated to continue to make the payments.

Annuities can also include a savings component that enables investors to defer their income into the future, and accumulate their capital, earning fixed or variable rates of return on a tax deferred basis. As an insurance contract, these deferred annuities include a death benefit that protects the principal for the beneficiaries in the event of a premature death.


If you look at your financial plan as a life cycle plan, where the different stages of life present different kinds of risk, the safety foundation you build should have the components needed to protect against each risk. For most people with young families who have yet to accumulate their capital, life insurance is a must. For older people, who are approaching the time when their accumulated capital needs to provide for them, capital preservation becomes the more critical objective. When they are a part of the safety foundation, annuities help retirees complete the cycle of life with the security of a lifetime of income.