Annuities aren't for everyone

Small gain in return offset by deferred payouts, penalties

June 17, 2008|By The Wall Street Journal

A shaky stock market and low rates on certificates of deposit have sent investors flocking to fixed annuities with deferred payouts. But they aren't a smart choice for many savers, particularly younger ones or those who may need ready access to funds.

In this type of annuity, savers often make a one-time payment. And the issuer of the annuity, an insurer, guarantees to pay a certain interest rate for a certain period of time.

Say you stuck $100,000 in a five-year deferred annuity at a 4.2 percent rate. In five years, you would get back $122,839. And you wouldn't owe taxes on the $22,839 in interest until you cashed out the annuity. If you had your money in a CD, you'd pay taxes every year.

The government aims this tax break at retirees. So if you're under 59 1/2 years old, you'll also get slapped with a 10 percent federal penalty on the gain when you cash out the annuity.

Sales of individual annuities of all types rose 9 percent in the first quarter of 2008, over the corresponding period last year, to $63.4 billion, according to Limra International, an industry research group.

Agents in banks may be promoting deferred annuities because the rates look enticing compared with other investments. The average yield on a one-year CD is 3.12 percent, and the average five-year CD pays 3.62 percent, according to A five-year deferred fixed annuity paid an average yield of 4.13 percent, and the highest rate available was 4.65 percent, according to

Deferred annuities can come with baggage, and you should read a contract carefully before signing one. Some have sizable surrender charges if you try to cash in the annuity before a specific period - sometimes as far out as 10 years. That makes them unsuitable for people with limited resources, especially the elderly. Regulators in several states and Finra, the financial industry watchdog, have issued warnings against unsuitable sales of deferred annuities to senior citizens. CDs also have penalties for early withdrawal, but they're mostly forfeited interest and tend to be less onerous.

CDs are federally insured up to $100,000. Annuities are guaranteed mainly by the financial strength of the insurance company that issues the contract.

The Right Call?

The impact of low interest rates::

* Sales of fixed annuities surpassed variables in the first quarter.

* But high surrender charges mean they're not a good alternative to a CD for many people.

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