Problems With Guaranteed Annuity Rates

by Wilhelm Schnotz, Demand Media

    Annuities with a guaranteed rate of return -- known as fixed-rate annuities -- can be a part of many retirement plans. You usually receive a fixed monthly sum for the rest of your life in exchange for a predictable monthly payment, which makes budgeting easier and helps ensure you won’t outlive your nest egg. While these investments can help your long-term planning, they are not without a variety of their own risks.

    Inflation

    Receiving $1,800 a month as a supplement to retirement pension and savings may seem like a good deal today, but in 25 years, the benefit may seem a little paltry. What’s worse, you’re paying for your pension in “old” dollars unaffected by inflation, and you receive “new” inflated dollars, so you may sacrifice spending power. For example, you’d need to receive $1,962 each month in 2013 to have the same spending power as a $1,000 monthly payment in 1988, according to the Bureau of Labor Statistics.

    Current Interest Rates

    When you buy into an annuity, you’re making an investment based on today’s interest rates, and fixed annuities are structured so that your benefit is based on the expected return on the investment. Because of this, if you buy into an annuity when rates are crummy, you’re locking yourself into a lifetime of low returns. This isn’t always a disadvantage: If you’re able to get into an annuity when interest rates are high, you’ll preserve those strong returns forever.

    Inflexibility

    All annuities are rigidly structured: You provide a large amount of cash up front and receive your defined benefit. While this ensures income and makes for easy budgeting, you also sacrifice your flexibility to leverage assets in an emergency. For example, if you place your money in the market and have massive medical bills two years later, you’ll be able to sell off parts of your portfolio to meet the unexpected costs. An equal investment in an annuity is tied up in the confines of your contract.

    Steep Exit Fees

    Most fixed annuities will give you a chance to void your contract and cash out, so if you really need to get at a pile of cash in an emergency or just want to reinvest at a higher rate than the one you’re locked into, that option is available. Expect to pay through the nose, though: Many annuities are structured with exit fees designed to discourage you from jumping ship. These fees are often referred to in annuity contracts as “back-end surrender charges.”

    About the Author

    Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.