Annuities are insurance policies that help you save money for retirement. Average returns on annuities are determined by the funds available in the annuity or the insurance company's general account holdings. Before you invest in an annuity, you have to understand your annuity's potential. Don't fly blind, because you could end up with a lot less at retirement than you expected.
A fixed annuity derives its interest from bonds and bond-like investments. These investments make up the insurance company's general account. The investments are bought and sold as they mature in the general account of the insurer. Thus, the interest rate reflects whatever is available in the marketplace. When the Federal Reserve sets interest rates low, the availability of high paying bonds may be slim or non-existent. When interest rates rise, so do the rates on fixed interest annuities.
Variable annuity rates are determined entirely by the funds available in the annuity and the investment allocation you choose. Dividend-paying mutual funds may be relatively stable and produce averages, which don't change much from year to year. Growth mutual funds may average 10 or 20 times higher than dividend mutual funds, or they may average much lower. This is due to the inherently volatile nature of a growth mutual fund.
An immediate annuity policy earns interest based on the insurance company's general account. However, insurers generally pay at least 95 percent of an annuity payment back as a return of principal. Only 5 percent or less of the annuity constitutes interest in most cases. This lowers the taxable investment gain of the annuity and spreads out the interest payments over your lifetime.
Only invest in annuities you understand. The most complex annuity might be the variable annuity, because it's so difficult to gauge the average return you can expect. Fixed annuities may earn between 1 and 5 percent, though this depends entirely on the interest rate environment and length of contract you purchase.