Considering an Annuity? Now’s the Time to Act

If you’ve ever considered an annuity, now’s the time to go shopping. And if you shopped for annuities months ago, it’s time to shop again.

For those not familiar with annuities, the following is a brief primer. If you’re already conversant with this investment product, skip down to “Why now’s the time to buy.”

Why invest with an insurance company?

Annuities are investments offered by insurance companies that allow your money to accumulate, then convert it into a monthly income for a certain period of time, or for life. As you’ll soon see, there are various types of annuities. But they all have one thing in common: They’re offered by insurance companies.

Insurance companies offer advantages over bank accounts, mutual funds, and other types of investments because insurance companies are treated differently under tax laws.

The two chief advantages:

Tax deferral: If you have a traditional IRA or 401(k), you know you don’t pay income taxes on the earnings until you take them out. Annuities offer the same advantage. As long as you leave the earnings alone, you don’t pay taxes on them. As with a retirement account, however, if you withdraw the money prior to age 59½, you’ll generally face a tax penalty.
Bypassing probate: When you set up an IRA or 401(k), you’re allowed to name a beneficiary. If you die, the beneficiary gets the money without the hassle and expense of probate. This, too, is true with an annuity, as well as with another common insurance product, life insurance.

Types of annuities

Now, let’s explore the various kinds of annuities.

Fixed annuities: CDs from an insurance company instead of a bank

Back in my investment adviser days, I’d use the exact words in the heading above to explain single premium deferred annuities, also known as fixed annuities, to clients. Because when you boil it down, that’s what they are: certificates of deposit (CDs) from an insurance company.

After allowing your fixed annuity to earn interest and accumulate, you can choose to get your money back or to “annuitize” it by converting it into a monthly income stream.

Like a certificate of deposit from a bank, when you take out a single premium deferred annuity, you agree to deposit a lump sum for a fixed amount of time, and the insurance company agrees to pay you a fixed amount of interest.

Unlike a certificate of deposit from a bank, however, the annuity is guaranteed only by the insurance company. There’s no Federal Deposit Insurance Corp. (FDIC) guarantee. And, as I mentioned above, as long as you let the interest accumulate, you won’t pay taxes on it.

Variable annuities: Mutual funds from an insurance company

A single premium deferred annuity is a CD clone. Its variable cousin is the insurance company clone of a mutual fund. Think of it as a mutual fund wrapped in an insurance contract.

Like with many mutual funds, you’ll often have various fund options, including growth (stocks), income (bonds) and balanced (both stocks and bonds). You can switch among various options without tax implications as long as you don’t take the money out.

There are also indexed annuities, which tie the returns of a variable annuity to a stock index, such as the S&P 500.

Most variable annuities offer something mutual funds don’t — a death benefit that guarantees that no matter how the funds perform, the beneficiary can’t receive less than the original investment.

As with fixed annuities, you can allow your deposit to grow, then convert it into a monthly income at some future date and duration.

Immediate annuities: Deposit a lump sum, get monthly income

This is what most people think of when they hear the word “annuity.”

With an immediate annuity, you give the insurance company a lump sum of cash, and they immediately begin paying you a monthly income. The income can be doled out in any number of ways. For example, it could last for a fixed number of years or for the rest of your life. Or it could last for the rest of your life and your surviving spouse’s life. There are a number of possibilities.

Obviously, the amount of money you’ll get monthly will depend on how much you deposit, as well as the length of time you expect to receive it. But if you’re looking for a predictable income in your retirement years — a pension substitute — this is where you might find it.

Potential problems with annuities

Thus far, I’ve highlighted the advantages of annuities. Unfortunately, it’s not all wine and roses.

For example, once you’ve invested in an immediate annuity, your money is tied up. There’s no unwinding the contract if a healthcare crisis or other situation creates a need for cash.

Another potential problem with virtually all kinds of annuities is fees. And as with mutual funds, fees are often not apparent.

For example, single premium and variable annuities routinely have back-end “surrender” fees lasting up to a decade. Variable annuities often have annual management and other fees in excess of 2.5% — many times more than some low-cost mutual funds. There’s also a charge for the death benefit offered by variable annuities.

Are annuities for you?

There are situations where annuities can fit into your financial plan. As with any investment, however, annuities aren’t all created equal, so comparison shopping is a must.

If you’re looking for an immediate annuity, compare monthly income and payout options. If you’re looking at fixed annuities, compare rates and surrender fees. With variable annuities, you’ll want to look at all the fees, plus the performance. And remember, guarantees are only as solid as the company making them.

Companies like Fidelity, known for low-fee mutual funds, also offer low-fee annuities. Another low-cost option is TIAA-CREF, although you’ll have to meet eligibility requirements.

Why now’s the time to buy

The reason annuities have recently become more attractive can be answered in two words: interest rates.

When you give an insurance company cash so it can be doled out to you monthly over time, it invests your money into bonds and other safe, interest-bearing investments. The more interest they earn, the higher your monthly income will be.

As you’re likely aware, interest rates on government and other bonds have been rising this year as the Federal Reserve raises rates to fight inflation. As insurance companies earn more, more should be passed along to annuity holders.

At some point, the Federal Reserve will reverse course and pivot from raising rates to lowering rates. When that will happen depends on when the Fed reaches its inflation goals. But whenever rates once again drop, annuity rates and payouts will drop with them.

Bottom line? If you have plans to convert savings into annuities, now’s the time to shop. One idea might be to put a third of your investment to an annuity now, then another third to a different annuity in a few months, and the final lump sum into a third annuity in six months.

But the key word is “shop.” Compare rates from different companies. And as with all investments, the more a salesman is trying to jam something down your throat, the more cautious you should be.

Avoid commission-based financial advisers. Rule of thumb: If you’re not paying them by the hour, you’re probably paying them in ways you’re not aware of.

Author: Stacy Johnson

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FINRA Compliance Reviewed by Red Oak:2565120

Fixed Annuities are long term insurance contacts and there is a surrender charge imposed generally during the first 5 to 7 years that you own the annuity contract. Withdrawals prior to age 59-1/2 may result in a 10% IRS tax penalty, in addition to any ordinary income tax. Any guarantees of the annuity are backed by the financial strength of the underlying insurance company.

Indexed annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company. Surrender charges apply if not held to the end of the term. Withdrawals are taxed as ordinary income and, if taken prior to 59 ½, a 10% federal tax penalty. Investors are cautioned to carefully review an indexed annuity for its features, costs, risks, and how the variables are calculated.

Please consider the investment objectives, risks, charges, and expenses carefully before investing in Variable Annuities. The prospectus, which contains this and other information about the variable annuity contract and the underlying investment options, can be obtained from the insurance company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

The investment return and principal value of the variable annuity investment options are not guaranteed. Variable annuity sub-accounts fluctuate with changes in market conditions. The principal may be worth more or less than the original amount invested when the annuity is surrendered.