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Fixed Income/Rate Investments

Finding suitable fixed income investments for retirees in today’s environment is perhaps the most challenging it has ever been.  With market interest rates at historic lows many income seeking investors are not left with many viable choices.  The investment returns on your traditional certificate of deposits (CD’s) you can get at your local bank or “secure” Treasury bonds offered by the U.S. government are so low that many investors must look for alternatives.Finding suitable fixed income investments for retirees in today’s environment is perhaps the most challenging it has ever been.  With market interest rates at historic lows many income seeking investors are not left with many viable choices.

Let’s take a look at some Fixed income/rate investments available for investors seeking a regular, stable source of income:
 
1) Fixed Annuities and Fixed Index Annuities

A strategy for an income seeking investor can be a fixed annuity or fixed-index annuity.  In today’s low interest rate environment, an investor can look to the higher rate of return offered in a fixed annuity or fixed-index annuity compared to the returns of a more traditional fixed income investment (i.e. CD’s, treasury bonds, etc.).  A fixed annuity is an insurance contract between an insurance company and an investor (annuitant) and pays a guaranteed minimum amount of income at regular intervals for a specified period of time.  Fixed and fixed-index annuities allows you to avoid the volatility of market swings, while providing guaranteed income and tax-deferred* growth.

*Tax deferral offers no additional value if an annuity is used to fund a qualified plan, such as a 401(k) or IRA, and may be found at a lower cost in other investment products. It also may not be available if the annuity is owned by a "non-natural person" such as a corporation or certain types of trusts.

Fixed Annuities

Regardless of market interest rate movements (refer to interest rate risk below), fixed annuities will continue to pay a guaranteed minimum rate of return for a specified time period.  There are two general types of fixed annuities.  Term Certain: A fixed annuity that will pay you a guaranteed minimum fixed rate for a specific time period.  Life Annuity: A fixed annuity that will pay you a guaranteed minimum fixed rate for your life. 

Fixed Index Annuities

A fixed index annuity pays a guaranteed minimum interest rate (much like a fixed annuity), however the amount of interest paid over the guaranteed minimum is linked to the movement of an external index (i.e. S&P 500 index).  The ability to link a portion of the return to an external index such as the S&P 500 index (widely considered to be a gauge of the overall U.S. stock market) allows an investor the potential to increase their returns during years where the stock market is positive.  This can be a very important tool to investors you would like a guaranteed minimum return on their investment with the possibility of higher returns.
 
2) Corporate Bonds and Municipal Bonds

There are important concepts and risks one should understand and consider before investing in bonds.   

Interest Rate Risk

A fundamental principal with bond investing is that market interest rates and bond prices generally move in opposite directions.  Interest rate risk is common to all bonds, even U.S. Treasury bonds.  The “seesaw,” pictured below, is a great representation to help you visualize this important relationship (interest rate risk).
When market interest rates rise, prices of bonds fall.

Other important risks to consider are credit or default risk, inflation risk, liquidity risk and call risk.
 
What are Corporate Bonds?

Corporate bonds (also called “corporates”) are debt obligations, or IOUs, issued by privately- and publicly-owned corporations. When you buy a corpo­rate bond, you essentially lend money to the entity that issued it. In return for the loan of your funds, the issuer agrees to pay you interest and to return the original loan amount – the face value or principal- when the bond matures or is called (the “matu­rity date” or “call date”). Unlike stocks, corporate bonds do not convey an ownership interest in the issuing corporation. Companies use the funds they raise from selling bonds for a variety of purposes, from building facilities to purchasing equipment to expanding their business.
 
Investors buy corporate bonds for a variety of reasons:

  • Attractive yields. Corporates usually offer higher yields than comparable-maturity govern­ment bonds. This higher yield is, however, gen­erally accompanied by higher risks.
  • Periodic income. Investors seeking steady income from their investments, while also pre­serving their principal, may include corporates in their fixed income portfolios.
  • Diversity. Corporate bonds provide an opportunity to choose from a variety of sectors, structures, and credit-quality characteristics to address investment diversification objectives.
  • Liquidity. Large and liquid sectors of the corporate bond market can provide relatively quick and easy marketability for investors who want to sell a bond before maturity. 

What are Municipal Bonds?  

Municipal bonds are debt obligations issued by states, cities, counties and other governmental entities, which use the money to build schools, highways, hospitals, sewer systems and many other projects for the public good.
When you purchase a municipal bond, you are lending money to a state or local government entity, which in turn promises to pay you a specified amount of interest (usually paid semiannually) and return the principal to you on a specific maturity date.

Not all municipal bonds offer income exempt from both federal and state taxes. There is an entirely separate market of municipal issues that are taxable at the federal level, but still offer a state — and often local — tax exemption on interest paid to residents of the state of issuance.
 
Investors buy Municipal Bonds for a variety of reasons:

  • attractive current income free from federal and, in some cases, state and local taxes
  • a high degree of safety with regard to payment of interest and repayment of principal;
  • a predictable stream of income;
  • a wide range of choices to meet your investment objectives regarding investment quality, maturity, choice of issuer, type of bond and geographical location; and
  • marketability in the event you must sell before maturity. 

Tax Advantages of Tax Exemption

Under present federal income tax law, the interest income you receive from investing in municipal bonds is not subject to federal income taxes. * In most states, interest income received from securities issued by governmental units within that state is also exempt from state and local taxes. In addition, interest income from bonds issued by U.S. territories and possessions is exempt from federal, state and local income taxes in all 50 states. * If you are subject to the Alternative Minimum Tax (AMT), you may have to include interest income from certain municipal securities in calculating your income tax.

One way to appreciate the tax-exempt advantage of a municipal bond is to compare it to a taxable investment.

5.0% Tax-exempt Bond7.0% Taxable Bond
Cash Investment$100,000$100,000
Interest$5,000$7,000
Federal Income Tax in The 33% marginal Tax Bracket$0$2,310
Net Return$5,000$4,690
Yield on investment After Taxes5.0%4.69%

As you can see, the municipal bond would provide the better yield after taxes are taken into account.  The tax-exempt bond yield advantage would be an even better investment if you accounted for state and local income taxes when calculating returns on the taxable bond investment.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are un-managed and may not be invested into directly.

Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.  Guarantees are based on the claims paying ability of the issuing company.

Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.  If sold prior to maturity, capital gains tax could apply.

The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bond yields are subject to change. Certain call or special redemption features may exist which could impact yield.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

For more information on Fixed Income/Rate Investments, please contact us today.


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