The Annuity Conversation You Should Be Having
Will your retirement savings last for the rest of your life?
Lincoln Financial Group, USA TODAY
- Annuity sales hit a record high in the second quarter.
- Investors seek to lock in higher interest rates and hedge against market fluctuations.
- Annuities can be a good addition to a diversified portfolio, but they can be complex and expensive.
If the recent market slump has made you nervous about your retirement funds, an annuity can help calm your nerves and protect you from giant market swings if used correctly, some financial advisers say.
This is probably why annuity sales are skyrocketing. Second-quarter sales are expected to hit $74 billion, setting a record, according to life insurance industry-funded research firm LIMRA. That would be more than $5 billion more than the previous record set during the financial crisis in the fourth quarter of 2008.
Record sales are driven by fixed-rate deferred annuities, which are expected to be between $25 billion and $30 billion, up nearly 75% from the first quarter. They work much like CDs, giving investors a fixed interest rate on their money for a certain period of time, but the interest rate on an annuity is usually higher than on a CD.
“There’s almost a perfect storm going on right now,” said Todd Giesing, head of annuity research at LIMRA. “Rates are going up, so you can earn more on those, and on top of that, the stock market is volatile. People are looking for security and guaranteed rates.
Variable and indexed annuities are the other two main types of annuities that make up the bulk of the annuity sales balance. Fixed annuities are considered the safest because you can’t lose the capital, and variable annuities are considered the riskiest because they move in step with the markets. An indexed annuity is considered somewhere in the middle.
What are annuities?
These are contracts with insurance companies to pay you regularly, starting now (immediate) or in the future (deferred). You can buy an annuity for as little as $10,000 in a lump sum or in regular periodic payments called premiums.
A lifetime income benefit option “can also be great if you’re worried about outliving your savings, as they can provide you with guaranteed income for the rest of your life, whether you live to be 100 or even 120,” Adam Politzer, Athene senior vice president of Product Actuary, said.
Some also have a death benefit, so if you die before collecting the annuity, your heirs receive the amount you contributed, plus investment earnings, minus any cash withdrawals you made.
“We often sell annuities to younger clients who have a long-term investment horizon and want to build their retirement savings tax-deferred,” he said. “We also often sell to recent retirees who want to make sure they don’t outlive their savings.”
What are the benefits of a deferred annuity?
Deferred annuities, sometimes called “longevity insurance”, ensure that there is enough money to fund late retirement.
They are good for long-term retirement planning, as income is not taxed until you start making withdrawals or receive periodic payments, although withdrawals before age 59 and a half years may be subject to an additional tax of 10%.
Unlike a 401(k) or an IRA, there are no limits on your annual pension contributions. “If you’re already contributing the most to other retirement plans, like an IRA or 401(k), an annuity can be an attractive option for continuing to save on a tax-deferred basis,” Politzer said.
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What are the benefits of an immediate annuity?
With these, you can invest a lump sum in an annuity and start receiving payments immediately to supplement your current income.
Plus, you only pay tax on the portion of your immediate annuity payments that is considered income, not on the principal, or the initial deposit made with after-tax money.
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What are the three main types of annuities?
Once you’ve decided whether you want a deferred or immediate pension, think about what you want from your pension.
A fixed annuity guarantees that you will earn a specific rate of interest on your investment and receive a fixed payment.
A variable annuity works similarly to a 401(k), allowing you to choose investments – referred to here as “separate accounts” – that resemble mutual funds. Returns and payouts vary with movements in the financial markets. However, they may offer death benefits and payment options that guarantee lifetime income and the fees may be much higher.
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An indexed annuity is a sort of hybrid of fixed and variable. It is pegged to an index like the S&P 500, offering a guaranteed minimum interest rate (like bonds) and a payout linked to a market index (like stocks). However, losses based on market indices are limited. In return for this security, potential gains are also capped. Between the two, the band in which the annuity can evolve is narrower than that of the market, which means less volatility.
Are there any disadvantages?
For one thing, they can be expensive.
The Securities and Exchange Commission warns of various fees on variable annuities, for example. Some include redemption fees if you cash out early, administration fees, underlying fund fees charged by mutual funds you may have invested in, and other fees related to features like long term care insurance you choose to add.
Variable annuities also move with the markets, so they wouldn’t offer much protection in a downturn.
Fixed annuities don’t adjust for inflation, which could erode your return. With a fixed rate, you also risk losing significantly higher rates, as people expect this year if you lock in now.
Insurance companies set a price on them, so you have to take their word for it and trust the company to remain solvent. The state insurance commissions, not the Federal Deposit Insurance Corp., regulate and underwrite them. So, check with the state insurance commissioner to make sure the broker is registered and licensed to sell annuities in the state.
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Are annuities worth it?
“They can all be beneficial if used correctly,” said Josh Simpson, vice president of operations and investment advisor at Lake Advisory Group in Lady Lake, Florida. “Nobody should put all their money in an annuity. Everyone should diversify. But if you don’t have an annuity and all your money is in the IRA, maybe consider one.
But like everything else, be sure to read the fine print. Annuities can be complex and include many fees that need to be taken into account.
“Look carefully at what the rules are about them,” Simpson said. “And don’t talk to an insurance company about buying one. Talk to an independent insurance agent and ask if they’re a fiduciary. If they say yes, go talk to them. The first consultation should not cost money.
Medora Lee is a money, markets and personal finance reporter at USA TODAY. You can reach her at email@example.com and sign up for our free Daily Money newsletter for personal finance tips and business news Monday through Friday mornings.