What the heck is an annuity part 2: fixed deferred

Posted By Paul

I came across another major annuity type called the "fixed deferred" or "fixed interest deferred" annuity that I wanted to talk about.

A fixed interest deferred annuity is kind of like a savings account, so I'm going to assume we all know what a savings account is and describe the annuity in contrast to that.

1) Like a savings account a fixed annuity gives you a known return on your money. In fact with fixed annuities you generally "lock in" an interest rate for some amount of time (like 5 years) and then after that interval has expired you "lock in" a rate again. One example is that Vanguard has a fixed annuity where if you open today you get a rate of 2.65% for the next 5 years. Note that this isn't a bad rate, in fact it's better than most CD's you can find right now.

BEWARE: I read about places where you get some awesome rate for the first year and then after that it resets to something lame, only now they have your money and you have to go through all kinds of hassle to move it.

2) Unlike a savings account, any interest you get is tax deferred. You don't pay taxes on it until you take it out.

3) Unlike a savings account, you can't just deposit and withdraw money whenever you feel like it. They vary, but it seems like most places have rules about how and when you can withdraw your money. The one through Vanguard for example says you can take out 10% of your savings in a year without penalty (but be careful, as with all tax deferred vehicles there can be tax consequences for getting your money out early). From my research it also seems that in most cases to add money you have to open a whole new annuity.

The above points generally capture what this type of annuity is. It's sort of like a 401k (you get the tax deferred part) and kind of like a savings account or CD (guaranteed interest).

So what are the pros and cons? Here is what I was able to come up with:
Pros: You get all the perks of a savings account PLUS tax deferral.
Cons: This is money you shouldn't plan on touching until the terms of the annuity are met. If you needed to "break open the piggy bank" early then tax and penalties could eat in to your money fast.

Overall, I think that this sort of annuity isn't a bad thing to consider if you've already given all you can to your 401k AND Roth IRA and still have money to sock away. When considering this sort of annuity BE SURE TO READ THE FINE PRINT and make sure you know what you're getting. Key questions to ask are:

1) What is my rate and how long does it lock in?
2) Is this rate an introductory rate?
3) How can I withdraw my money and what kind of withdrawal limits/penalties are there?
4) Is there any way to deposit additional money?

One interesting point is that when you compare this to my previous post:

What the heck is an annuity? Part 1

You'll see that this type of annuity is VERY different from the type I describe in my earlier post. As I mentioned before (and will mention again) that's one thing I REALLY don't like about annuities, it's such a broad term.

Once again I'll close with a quote from Warren Buffett about business investing, but it applies just as well to investment vehicles:

"Never invest in a business you cannot understand. "