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Since interest rates are so unpredictable, what’s the better buy: a fixed-rate annuity or a variable-rate annuity?


There are few personal-finance topics more complicated than annuities. Let’s skip over most of the myriad intricacies and cut to the two basic types of vehicles that you’re considering. One is a fixed-rate immediate annuity, which sets constant payments based on the amount of money invested, either as a lump sum or after a series of regular contributions, and the general level of interest rates when the annuity is purchased. The other type is a variable-rate annuity, in which the contributions are used to buy a portfolio of assets, typically stock or bond mutual funds. The payments made to the annuity holder are variable, as the name suggests, and depend on the returns that the investment portfolio achieves. Each type of annuity can feature tax breaks and a death benefit to a surviving spouse, but usually the annuity dies with the holder. That means that a portion of the payments that the annuity holder receives are a return of the original capital used to buy the annuity, they will be larger, all else being equal, than if the money had been placed in a savings account or investment portfolio directly.

The answer to your question these days, unfortunately, may be “neither.” Stock and bond markets are trading near record highs, so a variable annuity may entail more risk than anyone taking out such a product may realize. As for a fixed-rate annuity, you’re right that interest rates are unpredictable, but it could be easier than ever to predict the course of rates over the long term. The Federal Reserve has been manipulating rates to an unprecedented degree, keeping them far lower than they would be without any interference. The 10-year Treasury bond recently yielded about 1.75 percent, close to an all-time low, and short-term rates, such as on three-month Treasury bills, are effectively zero. If you take out a fixed annuity now, the payments for the rest of your life will be based on current rates. It seems like a bad deal.


-Conrad de Aenlle