Standard retirement plans, like 401k plans and IRAs, offer one way to accomplish your retirement savings goals. Private contracts from insurance companies offer another way. These private contracts are called deferred annuities. Annuities are insurance products that guarantee an income to you for a fixed time period or for your entire life, depending on how you want payments to be structured. Deferred annuities act like long-term savings accounts and defer the guaranteed income payment. Two types of deferred annuities are fixed and equity indexed annuities.
If you want the best interest rate earnings potential for a fixed annuity contract, choose the highest guaranteed rate possible. For equity indexed contracts, choose contracts with the lowest guaranteed rate.A guaranteed rate is the minimum interest rate you can earn in an annuity contract. High guaranteed interest rates are ideal for fixed annuities. But, a high guaranteed rate in an equity indexed annuity actually decreases potential returns in the policy. This is because an equity index contains two parts: the guaranteed rate and the equity indexed rate. High guaranteed rates require the insurer to hold more money in reserve to ensure that it can pay its promises in the contract while leaving less money to invest in the equity index which has a higher earning potential than the fixed rate portion of the contract.
Choosing the best fixed annuity or equity indexed contract means finding the policy with the highest overall interest crediting potential. Some contracts may have high interest crediting rates because they carry a fee. Ironically, this may translate into a better contract for you. For example, an annuity with a fee of 1.5 percent and an interest crediting rate of 5 percent, offers a better interest crediting rate than an annuity with no fee and a guaranteed 2 percent interest payment. For the best fixed or equity indexed contract, focus on total return potential of the policy, not just the fees charged in the contract.
A bonus on an equity indexed or fixed annuity means that you receive money over and above your ordinary interest rate stated in the contract. The bonus, however, may also decrease your potential interest earnings. Some insurers reduce the interest rate paid on contracts to reflect the fact that a bonus was earned. They may also mandate that you keep your contract for a certain length of time or you will lose the bonus when cashing out your annuity. For this reason, the best annuities and equity indexed products may be the ones with small or no bonuses. This way, you keep all of your earnings regardless of what you decide to do with your contract later. You also receive higher interest rate crediting potential.
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- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
I am a Registered Financial Consultant with 6 years experience in the financial services industry. I am trained in the financial planning process, with an emphasis in life insurance and annuity contracts. I have written for Demand Studios since 2009.