Why hanging on to your older fixed annuity is a solid bet

Clients who decided to hold on to fixed annuities of the past are benefiting from attractive yields, making the products a standout among fixed-income investments. Financial advisers note that some of their investors are holding on to attractive three-, five- and seven-year fixed annuities that pay a guaranteed minimum rate as high as 3%, even beyond the surrender period — and are relieved to have them in this era of paltry fix-income returns. “Older fixed annuities that have passed beyond their surrender periods are highly liquid, possess a high level of safety and are paying around 3%, which is often the policy minimum,” said James Heitman, founder of Compass Financial Planning. Getting a comparable return on Treasurys would require investors to consider longer-term securities, he added. Older fixed-annuity contracts drawn up several years ago were drafted at a time when the carriers' bond portfolios were performing well, thanks to higher interest rates. That enabled the insurers to pass some of the benefit to the client via an attractive credited rate that's declared annually and an attractive guaranteed minimum rate, while still making a profit on the spread. However, as interest rates fell, putting pressure on fixed-income investments, it's become less profitable for insurers to continue paying customers high rates, especially when clients choose to cling to their fixed annuity after the surrender. “There was a time when the 10-year Treasury was up around 5% or 6%, when if someone didn't surrender a contract, the companies were delighted to keep the money,” said Judith Alexander, director of marketing at Beacon Research Publications Inc. “But now with a 3% or 4% guaranteed rate contract, they'd probably love for you to surrender it.” As of late, insurers' new fixed-annuity contracts are featuring a 1% to 2% guaranteed minimum rate. Alternatively, insurers might promise a first-year rate of 4% but drop it as low as 2% for subsequent years. Fixed annuities with a guaranteed 3% floor are hard to find and few are on the market. Meanwhile, clients who are still holding on to the more generous fixed annuities aren't taking income from them as the products approach the end of their surrender periods. Rather, they're using them as an alternative to a CD and continuing to accumulate interest on a tax-deferred basis, noted Scott Stolz, president of Raymond James Insurance Group. “This is one of those products where the surrender period ends and you continue with a rate that's higher than what you'd get on anything else,” he said. “Clients who locked in these rates are happy; they're the ones who want a constant guaranteed rate of return without any risk to their principal,” said Richard Dragotta, an adviser with LPL Financial LLP.