Misconceptions Can Arise As Banks Push Annuities Over CDs
( FOX BUSINESS )- That same insurance-licensed person who sold you your bank CD soon may try to sell you a higher-yielding tax-deferred fixed annuity.
"In January and February, there has been an explosion of fixed annuity sales (in banks)," says Kenneth Kehrer, director and co-founder of Kehrer-LIMRA, Windsor, Conn.
"Now banks are one of the leading (sellers of) annuities," says Andrew Singer, managing director of Bank Insurance Market Research Group, Mamaroneck, N.Y.
Deferred fixed or fixed-rate annuities are the types of annuities that most resemble bank CDs. In mid-February, they had a 5.22% initial one-year rate, including bonuses, versus an average 2.47% on a one-year bank CD, according to Kehrer-Jackson Bank Fixed Annuity RateWatch and Bankrate.com, respectively.
Even without the bonuses, the bank-sold fixed annuity rate would average more -- 3.49%.
But there are major differences between bank certificates of deposit and tax-deferred fixed annuities, which are contracts with life insurance companies. With a deferred fixed annuity, you typically have the option, at maturity, to withdraw your money or annuitize the contract. This means you can get periodic payments for life.
Here are misconceptions that could arise when you hear about tax-deferred fixed annuities in the confines of your bank and what the true state of affairs is:
A tax-deferred fixed annuity means your interest rate is fixed for the contract, similar to most CDs. This is true in the majority of sales by banks, says Judith Alexander, director of sales and marketing for Beacon Research, Evanston, Ill. Nearly all deferred fixed annuities sold through banks have a "minimum guaranteed rate," ranging from 1% to 4%, she says. This is the least you can earn -- generally even if the insurance company goes into receivership. They also have an initial "declared rate." Often this rate lasts for your entire contract term, but other times it may be reset by the insurance company. Deferred fixed annuities are safe. Perhaps. But even if you buy an annuity at your bank, it does not come with U.S. government-backed FDIC insurance, which is limited to bank deposits. Fixed annuities, though, are guaranteed by the insurance company. If a licensed insurance company goes under, it's backed by a state guaranty association. Fixed annuities are a great investment if you're retired. While certain types of fixed income annuities might be attractive for retirees, deferred fixed rate annuities, more commonly sold by bank branch employees, could prove too illiquid. Those are designed for accumulation, Singer says. Not only might you pay a 10% IRS penalty if you cash out before age 59 1/2, but you could face very steep surrender charges. Surrender charges, set by the insurance company, often decline 1 percentage point annually and start around 6%, according to Kehrer. Beacon Research has tracked surrender charges as high as 18% and as low as 1% on bank-sold deferred fixed-rate annuities. A high rate can mean steeper surrender charges. Add bonuses on deferred fixed annuities directly to the base rate to determine your yield. Not necessarily, Alexander says. Instead, "prorate the bonus over the term of the contract." Say you invest $100 in a deferred fixed annuity that promises 5% annually for five years with a 1% first-year bonus. It seems like you're earning 6% annually. But on average, you're only really getting 5.2% annually. Of course, you could make a similar mistake with limited-time bonus CD rates. So shop accordingly.
Major considerations if you're considering a deferred fixed annuity instead of a CD at your bank:
Deferred fixed annuities are tax-deferred. CDs, unless you shelter them in an IRA or other type of retirement account, generally are not. Regardless of how low an insurance company's surrender charges might be, don't neglect the fact that the IRS may levy its own 10% penalty if you withdraw before age 59 1/2. Also, check whether its market value can adjust if you withdraw early. Even though your declared interest rate is "guaranteed" by the insurance company, the guarantee only is as strong as your insurer. So evaluate its strength with ratings agencies, such as A.M. Best and Standard & Poor's. Bank deposits, including interest, are guaranteed by the FDIC at least to $100,000 per person per bank, $250,000 for IRAs. If a bank fails, your CD contract may be broken and the interest rate slashed. However, you'd be able to withdraw your funds. If the insurance company issuing your annuity failed, a state guaranty association would back your annuity -- at least to $100,000. The guaranty association would likely refer to your contract's "minimum guaranteed rate." If excessive, it could be adjusted based on a formula tied to Moody's corporate bond yield average. You'd still likely owe surrender charges if you withdraw during the surrender period. Nevertheless, you should continue to receive any annuity payouts to which you're entitled.