Annuities Rising in Popularity
As interest rates increase, so does the appeal of annuities. How much do you know about these insurance products?
Rising interest rates are making annuities more attractive to investors, so much so that annuity sales are smashing records set in 2008 during the Great Recession. Annuities, which can provide retirement income, are also becoming an option for workers whose employers aren’t providing pensions.
Total U.S. annuity sales increased 22% to $77.5 billion in the second quarter of 2022, according to preliminary survey results from LIMRA, a financial services trade association. These numbers represent the highest quarterly sales since LIMRA began tracking annuity sales in 2014 — $9 billion above the previous record in the fourth quarter of 2008.
While they may be enjoying a new surge of popularity, the concept of annuities dates back to early Rome, when citizens would make a lump-sum payment to a contract called an annua in exchange for income payments received once a year for the rest of their lives.
Modern-day annuities are more complicated than that, even though they’ve kept the name, and they’re not for everyone. Before considering an annuity, there are some basics you should know, including what annuities are, what options they provide and how safe your money will be.
Read on for those answers and more.
What Is an Annuity?
An annuity is an insurance contract where you, the purchaser, pay an insurance company to invest your money, allowing it to grow tax deferred. In some instances, the annuity later provides a stream of income, according to the contract provisions, which could cover a set length of time or be for life. In this sense, annuities are insurance against outliving your savings because they pay for as long as the contract provides, even if the underlying principal and any earnings have been depleted.
If you have a lifetime annuity and live a long time, you could receive a total far more than whatever you originally put in. However, depending on the terms of the annuity, it’s also possible that you might die before recouping your investment.
Annuities are classified in several different ways, including how they are purchased and how the funds grow. They can also be customized with different contract provisions known as riders. For example, an annuity could include a long-term care rider that increases your payout should you require long-term care. Or a rider could provide for funds from an annuity to go to a beneficiary should the annuity holder die before receiving the funds.
You should keep in mind that these riders cost money, meaning if your annuity pays an income stream, the income payments will be smaller.
In other instances, an annuity may pay a lump sum at a specified date.
Annuities vs CDs: Which Pay More?
Annuity shoppers may be seeking the security of a certificate of deposit, but with a better return. These days, annuities are delivering that.
“Continued equity market declines and rising interest rates drove investors to purchase record-level fixed-rate deferred annuities in the second quarter,” said Todd Giesing, assistant vice president at LIMRA Annuity Research. “Our research shows fixed-rate deferred annuity manufacturers are, on average, offering interest rates more than four times that of a bank CD, which has made these products a tremendous value for investors looking for protection and growth potential.”
In June, according to LIMRA, the three-year average interest rate for a fixed-rate deferred annuity was 2.98%, compared to an average interest rate of 0.64% for a three-year CD. You can find current information on annuity rates online. One source is Annuityexpertasdvice.com. For rate information about CDs, you can go to https://www.depositaccounts.com/.
Immediate Annuities vs. Deferred Annuities
When it comes to how they are purchased, there are two types of annuities: immediate annuities and deferred annuities. Immediate annuities will begin paying a stream of income within a year of their purchase. They are best for retirees who want to receive payouts right away.
Deferred annuities are better for people who are still saving for a future retirement. The money they invest grows tax-deferred until it is withdrawn later.
A deferred annuity requires a smaller outlay of cash. You can also add to it before the payout. With this annuity, you get guaranteed payments or a lump sum when you reach a certain age. You might also elect to roll your deferred annuity over into another deferred annuity that pays out at a later time.
How Do Annuities Grow Your Money?
Beyond the distinction of when annuities start paying (immediate vs deferred), annuities also offer a range of flavors in what they pay out.
Different annuities grow at different rates:
- If your contract calls for a fixed-rate annuity, the funds will grow at a fixed rate of interest for a period of years specified in the contract. When the term is up, that rate can reset for the next period.
- Variable annuities allow you to invest your money in mutual-fund-like subaccounts, so the payout will follow the performance of the portfolios.
- And indexed annuities will have their rate of growth tied to an index, such as the S&P 500.
Sales of fixed and indexed annuities have benefitted the most from the current economy, while variable annuities have not done as well.
The second quarter of 2022, LIMRA says, was the best sales quarter for fixed-rate deferred annuities ever recorded. Their total sales were $28.2 billion in the second quarter, 76% higher than second quarter 2021 sales.
Fixed indexed annuity sales were $19.7 billion in the second quarter, up 19% from the prior year.
But variable annuity sales fell 32% to $15.4 billion, the lowest quarterly results since the fourth quarter of 1995. For the year, variable annuity sales were down 22% from the same period in 2021.
“Both FIAs and fixed-rate deferred products benefited from the significant interest rate increases in the second quarter,” Giesing said. “Coupled with a nearly 20% equity market decline, investors sought out principal protection and growth potential, which these products offer.”
Annuity Payouts: Single Life vs. Joint Life
If you buy an immediate annuity, you’ll get the highest annual payout if you buy a single-life version—one that stops payouts when you die, even if your spouse is still alive.
But if your spouse is counting on that income, it may be better to take a lower payout that will continue for his or her lifetime, too. (Some annuities are guaranteed to pay for a certain number of years, even if you and your spouse die during that period.).
Annuity Payouts: Men vs. Women
In general, if you have an annuity that pays income for life, the longer your life expectancy, the smaller your payments will be.
Consequently, the older you are when your annuity starts sending you payments, the higher your payments will be because your life expectancy is shorter. For this reason, some people ladder their annuities — investing some money early in retirement to cover expenses, then adding more when they get older to boost payouts. Plus, laddering can allow you to take advantage of rising interest rates: Each new contract will have the latest rate.
This is also why men receive higher payments from their life income annuities because men usually have a shorter life expectancy than women and, on average, will receive fewer payments.
You'll Pay Fees for Cashing Out Your Annuity Early
Although deferred annuities let you cash out at any time, you may not get all your money back. You generally have to pay a surrender charge that starts at about 7% to 10% of the account balance in the first year, and gradually decreases every year until it disappears after seven to ten years. Also, if you take the money before age 59½, you generally have to pay an early-withdrawal penalty of 10%.
Your Annuity Is Protected Even If the Insurer Goes Bankrupt
It’s important that you purchase your annuity from an insurance company that is financially secure. Annuities are not regulated or insured by the federal government – but as an insurance product, are overseen by states. If you have a fixed deferred annuity or are receiving fixed immediate annuity payouts, then your payouts are protected by your state guaranty association. The level of protection varies by state. Find your state limits at the website of the National Organization of Life & Health Insurance Guaranty Associations.
You Could Buy an Annuity Within a 401(k)
A growing number of companies are giving employees the option of investing in an annuity in their 401(k) plans that can be converted into guaranteed income after they retire. And since federal retirement law requires 401(k) plan providers to vet annuity providers to make sure they’re in compliance with state laws and have healthy financial reserves, that could make this avenue more appealing than buying annuities on the open market. Plus, annuities bought through a retirement plan may also benefit from institutional pricing, which means they could come with lower fees,
The annuity offerings from big plan managers like TIAA-CREF and Fidelity are generally aimed at replacing the fixed-income holdings of 401(k) participants. But the greater complexities of annuities (over, say, a mutual fund or ETF) don’t go away just because they’re purchased in the more familiar confines of a 401(k). For example, if you add an annuity to your mix, you will still need to decide when (or whether) to annuitize — that is, convert it into a guaranteed income stream, a decision that’s usually irrevocable.