5 Tips for Buying an Annuity for Retirement Income
One popular type, called a Multiyear Guaranteed Annuity, lets you lock in as much as 5.8% for several years
Personal finance journalists and advisers have often discouraged people from buying annuities for retirement income because the financial products can be complicated and laden with high, hidden fees.
But rising interest rates are now making a particular type of annuity — known as a Multiyear Guaranteed Annuity or a MYGA — worth considering, experts say.
Generally speaking, an annuity is a financial contract where you give an insurance company a lump sum — often $20,000 or more — and the insurer guarantees to send regular payments to you for the rest of your life. The guarantee is from the insurance company, not the federal government.
"An annuity is a legal contract. Some annuities are great and some stink."
"An annuity is a legal contract. Some annuities are great and some stink," Pam Krueger, founder of the financial advisory vetting firm Wealthramp.com, said on a recent episode of the "Friends Talk Money" podcast. (Full disclosure: I co-host that podcast along with Krueger and the personal finance journalist and author Terry Savage.)
What Is a MYGA Annuity?
A MYGA annuity is the insurance industry's version of a bank CD. It lets you lock in an interest rate for a term ranging from two to 10 years; the upper range of current rates is about 5.5% to 5.8%. When the term ends, the rate can be increased or decreased at the insurance company's discretion.
Earnings in a MYGA grow tax deferred. But unlike the gains in tax-deferred IRAs and other retirement savings products, MYGA gains are taxed as regular income when withdrawn, not as capital gains, which usually have lower levies.
Because current interest rates are so high, "multi-year guaranteed annuities are flying off the shelves," said Stan Haithcock, a fixed-annuity salesman in Ponte Vedra Beach, Florida.
Annuity sales, in general, have been very strong lately, surging 22% in 2022, according to LIMRA. Fixed-rate annuity sales more than doubled last year.
5 Caveats About MYGA Annuities
But there are five things to keep in mind before buying a MYGA annuity:
First, the guarantee is only as strong as the insurance company behind it. Credit-rating agencies such as Moody's, Standard & Poor's and A.M. Best give insurers letter grades for their financial health.
Haithcock said that on a safety scale, U.S. Treasuries are at the top, followed by bank CDs — backed by the Federal Deposit Insurance Corp. (up to $250,000 per depositor per bank) — and then MYGAs.
If an insurer is unable to make promised payments, annuity holders may wind up getting less than they expected.
"While the Fed recently has been raising rates, a lot of the annuity companies have actually lowered their guarantees."
State insurance guarantee funds act as a backstop for fixed annuities like MYGAs, but they have dollar limits on their payouts. Each state has its own rules; the typical coverage limit is $250,000. New Jersey's limit is just $100,000; Connecticut, New York and Washington are as high as $500,000.
Second, an insurer's MYGA guaranteed rates won't necessarily mirror interest rates on bank CDs or Treasuries. "While the Fed recently has been raising rates, a lot of the annuity companies have actually lowered their guarantees," Haithcock said. "When these companies are getting in enough money, they're not going to raise rates just because of what [Fed] Chairman Powell did."
Third, MYGA rates depend on where you live and the insurer you choose. "Annuities are issued at the state level, so every company has to go get approval in the state," Haithcock noted. Once an insurer is approved by a state, the company can then decide the rates it will offer.
Recently, three-year MYGA guarantees in Alabama ranged from 2.5% to 5.75%. In Wyoming, they ran from 2% to 5.53%. Lately, rates overall tend to be highest on 5-year and 7-year MYGAs.
Right now, "if the duration you're looking for is less than three years, buy CDs and Treasuries; if it's past three years, then multi-year guarantee annuities are going to provide a higher contractual guarantee," said Haithcock.
Fourth, if you need to withdraw money from a MYGA during the term of its guarantee, you may owe a surrender charge.
Each insurer has its own rules regarding withdrawals. Some let you withdraw up to 10% of your account balance each year without a penalty; others don't.
"If some salesman says: 'You really need to buy it because this deal's going away,' let it go away."
So, before buying a MYGA, think about whether you may want to pull out some of your money during its guaranteed term and shop accordingly.
Fifth, returns on MYGA annuities — like other fixed annuities — can get eaten up by inflation.
"Even 3% inflation will cut the spending power of your money in half in less than 25 years," noted Savage.
A Riskier Type of Annuity
Also worth remembering: MYGA annuities are very different from riskier annuities whose returns are tied to the stock market, known as index-linked annuities or fixed-index annuities.
They let you earn returns pegged to the stock market, but with a limit known as a "cap." Some index-linked annuities buffer you against stock market losses.
Haithcock has two more tips for buying annuities:
The first is: "If some salesman says: 'You really need to buy it because this deal's going away,' let it go away."
The second: "If you can't explain it to a nine-year-old, you shouldn't buy it. No offense to nine-year-olds."