Perhaps you seek the best annuities that you can use to grow for now and then provide income for your later retirement years. While the two best annuities you locate may seem similar on the face, what about later when it's time for the rate to change? Here's how to get an insight into which will turn out to be the winner of your two best annuities.
Fixed annuities are under the regulation of the state's department of insurance. These regulations restrict the particular annuity company's options for investment to ensure that it can meet up with its fixed annuity obligations. In other words, annuity companies are limited to relatively safe investments to back up their issued annuities.
When researching potential opportunities in for the best annuities you might come across a pair of companies that offer the same attractive terms. Both contracts may offer the same initial interest rate, identical guarantee rates, the same surrender charge schedule, and identical withdrawal features. On the face of things, you have located the two best annuities. Nevertheless, once the initial rate period expires, each company will set a renewal rate in its own investment discretion. You need to understand the standards a company will consider prior to setting the new rate so that you have indeed selected the best annuity for the long term.
The earnings an annuity company obtains from its bond portfolio depends on the quality of the securities and their average maturity. These two factors are related to risk and, as a result, affect the yield. The general rules are
- the more risky the securities, the greater the yield
- the greater the duration (i.e term), the higher the yield
In most cases, better the bond quality, the lower the potential risk of default. However, the higher rated bonds also yield less interest. Companies with portfolios carrying greater risk obtain higher yields so long as the risk they take is prudent, they can pay the annuity contract holders more. Companies that issue the best annuities typically have a more talented or insightful investment management team that can wisely get a higher return without undue risk.
Yet another factor that impacts portfolio risk and return is the duration of the bonds. Bonds with a longer maturity usually generate more yield than bonds with short maturities. One can get information on the quality and duration of the portfolio held by the insurance company just by asking for it. Yes, it may seem like a lot of details to look at, but you won't find the best annuities by guessing or a cursory search.
Let's look at the interplay of these factors in comparing our best annuities. We can take into account two annuity companies with bond investment portfolios that have different average maturities nevertheless offering the same deferred best annuities. In our hypothetical example, both annuities yield 5% and other aspects are equal.
The table below illustrates that annuity company A, which in turn owns bonds with longer maturity, will be trapped in the event that interest rates go up and can only offer a 5% renewal rate. However, if interest rates fall, it might easily maintain the 5% payout. Company B, which has short maturity ties, must necessarily buy more bonds as their bonds mature. The interest earned on the new bonds will be at the prevailing interest rates and determine how much the company can pay on your annuity renewal. This may either be beneficial or not with respect to the direction in which interest rates have moved.
| Annuity Company A | Annuity Company B | |
| Average Bond Maturity | 15 yrs | 8 yrs |
| Current yield | 5% | 5% |
| Renewal rate under rising prevailing rates |
Selling would cause loss of fund's value - offer 5% again |
Almost matured –must buy and offer higher rate |
| Renewal rate under falling prevailing rates |
No need to sell , offer 5% again | Almost matured - must buy and offer lower rate |
A few annuity companies might give you a high 'teaser' initial rate and recoup related losses by offering significantly reduced renewal rates later. By reviewing the actual renewal rate history of companies you will be able to pick out the company offering truly the best annuities. You can obtain the needed data by asking for it.
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