Annuities are the Rodney Dangerfield of income investments. They don’t get no respect.

Many investors ignore the complementary and important role annuities can play in retirement portfolios. However, when you want higher yields than cash and fear what rising rates will do to bonds, consider putting the safe or fixed-income portion of your portfolio in certain types of annuities.

Note that I’m recommending you consider only particular types of annuities. I’m not recommending the high-fee variable annuities that are roundly criticized. Unfortunately, many critics of variable annuities shorten their advice to, “Don’t buy annuities.”

Below, I focus on three types of annuities.

Deferred fixed annuities. These are a classic, plain vanilla annuity. You make a deposit with an insurer, usually a lump sum but periodic deposits also are possible. Each year the insurer credits a return or yield to your account.

Typically, the yield is determined by the insurer based on its expected investment returns, expenses, and other factors. Yields on deferred fixed annuities usually are about the yield on intermediate investment-grade or mortgage bonds. There usually is a modest guaranteed minimum yield. The interest credited to your account compounds tax-deferred until you withdraw it.

You’re likely to have limited access to the money in the annuity. Most insurers limit withdrawals to 10% of the principal per year without penalty for at least a period of time. You probably won’t be able to take your money back or switch it to another insurer’s annuity without penalty for at least seven years.

Take a look at the following chart, with data as of March 2024, that depicts the best fixed annuity rates:

Source: Annuity.org

Insurers offer optional features on deferred fixed annuities, including having more access to your money. But those features generate higher fees and reduce your returns. They generally aren’t worth the cost.

The advantages of a deferred fixed annuity are a healthy yield that rises over time if market rates rise, tax-deferred compounding, and safety of principal. Of course, your account’s value won’t decline as interest rates rise. The main disadvantage is restricted access to your money.

Deferred indexed annuities. In principal these are similar to deferred fixed annuities. The main difference is that with an indexed annuity the return on your account is determined by reference to an external index, such as a stock market index. With a fixed annuity, the insurance company sets your yield each year.

With an indexed annuity, you don’t earn the full return of the index. Instead, a formula determines the amount credited to your account based on the performance of one or more indices.

There are four main formulas and variations for each formula, but we don’t need to go into details here. On top of that there might be a limit to the amount of the index return you receive, known as the participation rate. For example, your account might be credited 70% of the return calculated by the formula. Plus, there’s usually an absolute limit on your annual return, known as a cap, that usually is 8% to 10%.

There are a lot of differences between different fixed indexed annuities (FIAs) on all these details. The result is that when the index rises 12%, some FIAs are credited with a 5% return while others receive 10% and a bunch receive something in between.

An FIA has a guaranteed minimum return, which is 0% for most these days. So, you’re guaranteed not to lose money even if the index does. Then, you have the potential of earning more than a deferred fixed annuity if the index does well, though you could earn less than a fixed annuity if the index doesn’t do well.

There are literally hundreds of different formulas for crediting interest to FIAs. Visit this link for a comprehensive list of FIAs and the rates that they currently offer.

As with a deferred fixed annuity, there are restrictions on access to your money. If you want to withdraw all your money or transfer it to another insurer’s annuity within seven years, you’ll pay a penalty. You might have access to up to 10% of your account each year without penalty.

The FIAs also can have a number of optional provisions that offer more access to your money and other features such as lifetime income payments and death benefits. These riders in my view usually aren’t worth the extra fees, but you can decide if they meet your needs.

Immediate annuities. The deferred fixed annuity and deferred index annuity generally are for money you aren’t planning to spend in the next seven years or longer. When you already are retired and drawing income from your bond investments, these might not be the best replacements for bonds. Instead, you should consider an immediate annuity.

These are the classic annuities. You deposit money with an insurer, and it begins making guaranteed regular payments to you. The payments last for the rest of your life, the joint life of you and your spouse, or a guaranteed term of years, whichever you select. The payments aren’t purely income. They are both income and a return of your principal. Once you pass life expectancy, payments are all income.

The best multi-year guaranteed annuity (MYGA) rate is 5.60% for a 10-year surrender period, 5.80% for a seven-year surrender period, 5.75% for a five-year surrender period, 6.00% for a three-year surrender period, and 5.25% for a two-year surrender period.

You have limited or no access to money beyond the guaranteed annual payments, depending on the annuity you select, so you should have other assets or income to tap in case of unexpected spending. The payments vary considerably from insurer to insurer. Shop carefully.

All annuities are a trade off. You transfer to the insurer the risks of low (or negative) investment returns, unexpected expenses, and, in the case of an immediate annuity, a long life. In return, you have limited access to the money on deposit with the insurer and give up the potential of earning a higher return with that money. In today’s investment world, you also transfer to the insurer the risk that rising interest rates will reduce the value of bonds.

Because of the trade offs, there are few people who should put all or most of their money in annuities. But the right annuities can be a valuable addition to the nest eggs of most people.

Editor’s Note: If you’re looking for ways to generate safe and steady income, regardless of the market’s ups and downs, consider my colleague Robert Rapier.

Robert Rapier is chief investment strategist of our premium advisory, Utility Forecaster. No one understands dividend-paying stocks better than Robert.

After painstaking research, Robert found a rare type of investment that has raised its payouts by double-digits every year for the past 16 years. If you’re tired of anemic payouts, Robert has the remedy. Click here for details.

John Persinos is the editorial director of Investing Daily.

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