What You Should Know About Annuities

Controversial to some, complicated to others, annuities are having a moment, with more retirees than ever turning to them for reliable income and tax-deferred investments. This has pushed sales to reach record numbers in the past year. 

A combination of factors has juiced interest in annuities:

• A bulging population reaching retirement age without the same level of income from pensions as the previous generation, but with longer life expectancy.
•  A spike in interest rates is making fixed-rate annuities—the most popular kind—more lucrative investments able to generate higher returns and potentially more income than any time in more than a decade.
•  Ever Increasing stock values have given retirees more wealth that they are seeking to protect and transform into income to replace pensions.

Whether any individual should buy an annuity is, like most financial issues, a personal decision that depends on a person’s needs and assets, as well as priorities and plans for the future. 

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For those whose financial goals would be met by an annuity, this is a good time to buy, says Frank O’Connor, vice president of research at the Insured Retirement Institute, an annuity industry association. Because interest rates are higher than in the past, “you'll either get higher yield or higher payments, depending on whether you're buying the annuity for accumulation and wealth building or whether you're buying it for income,” he says. “So it is a good time relative to past periods when interest rates were significantly lower.”

Nonetheless, Micah Hauptman, director of investor protection for the Consumer Federation of America, warns against trying to time a purchase based on market conditions, which he says amounts to “speculation.” He adds, “as a general rule, market timing rarely works out in investors’ favor.”

Getting an annuity is “not a decision that should be made lightly,” Hauptman adds, ”given the fact that they can be pretty costly to reverse.”

Not so popular 

Traditionally, a relatively small portion of the population has invested in annuities for retirement income. Just 12% of households with assets over $100,000 receive any annuity income, according to a study of people 50 and older by the University of Michigan.

But more people are turning to annuities with sales reaching records, soaring above $385 billion in 2023. That’s a jump of more than 23% from the previous year and 58% higher than 2014 sales, according to figures from LIMRA , a trade group that tracks the industry.  

“There are a number of tailwinds” helping push these increasing sales, says Keith Golembiewski, head of LIMRA Annuity Research, including higher interest rates and strong equity markets. While experts agree that no specific interest rate signals the best time to buy annuities, Golembiewski says annuities that offer 5% rates are resonating with advisers and clients now. 

Get more for your money 

If you wanted to get an income stream of $15,000 a year starting at age 65, it would have cost you about $300,000 as recently as two or three years ago, says Michael Finke, professor of wealth management at The American College of Financial Services. Now, you can get that $15,000 a year for close to $200,000.

Will it get better? That depends on what happens with interest rates, which are difficult to predict. Interest rates aside, O’Connor, at the Insured Retirement Institute, says the way to get the highest income payments for your money is to get a life-only immediate annuity, which will pay income your entire life—even after the principal has been exhausted—but not guarantee return of principal if you die before collecting the full amount. 

Most people want to ensure that they or their beneficiaries won’t lose out on the underlying investment, however, O’Connor says. Guaranteeing that costs money, which means less annual income from the annuity. 

Another way to increase the amount of annual income is to start the income when you’re older. The older you are when you start the income, the more income you can get.

For example, Finke says, if he, at the age of 54, spends $200,000 now on an annuity to buy an income stream that will start when he turns 85, he can get about $200,000 a year in income every year for as long as he lives.Knowing that income will kick in when he’s 85 means it’s easier to comfortably spend the rest of his money in the years between the age of 65 and 85.

Funding a long life 

More than half of Americans say they want to live to be 100 years old, according to a survey by Corebridge Financial, but 55% also  say they are extremely or very concerned about running out of money.

The good news is that if you’re considering buying an annuity, you’re probably going to live longer than someone for whom an annuity is out of reach. That’s because research has shown that people who contribute to defined contribution plans, such as 401(k)s live much longer than those who don’t, Finke says.  

“So people who have enough money to worry about this are going to live significantly longer than the average American,” Finke says. “And it's really dramatic; people who make more money in the United States live a lot longer, mainly because of differences in smoking rates and, to a lesser extent, exercise and diets and access to health care.”

But the prospect of living longer paralyzes the spending of some retirees, who consequently live more frugally than necessary, depriving themselves of the enjoyment they worked hard to afford.

“I think one of the biggest mistakes people make is that they want to  put their arms around their nest egg and keep it forever and they don't have a realistic conversation with themselves about what the goal of that money is,” Finke says 

Different annuities meet specific retirement needs, says Mike Harris, a senior education adviser at the Alliance for Lifetime Income, which promotes annuities.  Some annuities are used like certificates of deposit — places to keep money for a set period of time where it can grow at a specified interest rate. And unlike CDs, annuities’ growth is tax deferred, meaning the added funds are not taxed until they are withdrawn. 

But the real strength of annuities is their ability to create a lifetime income stream. “That's where they shine,” Harris says. “There's only three ways to have a guaranteed lifetime income: Social Security, pensions and annuities. That's it. Nobody else can guarantee the income off of any product.”

Stan Haithcock, also known as “Stan the Annuity Man,” sells annuities and educates consumers online. He says only people who have financial needs that annuities are designed to address should buy them. So, for example, if you’re looking for guaranteed income or principal protection, consider an annuity. But if you hope to get investment returns similar to the stock market, stocks are a better idea.

“That's the biggest mistake people are making, if they're buying annuities for potential market growth or a very good sales pitch, when they should be buying them for the contractual guarantees.”

Satisfied with their choices 

For Phyllis Gresham, 90, of Fort Myers, Fla., relying on annuities to fund her retirement income for life is a no-brainer. The retired nurse practitioner says she lives comfortably without worrying about money because of the income she receives as a result of her late husband putting all his retirement funds into annuities when he retired more than 25 years ago from his career as an academic physician. While she says she has slowed down a bit in the past couple of years, she continues to lead an active life and says having reliable, steady income has enabled her to do the things she enjoys. Money, she says, is “not a worry.”

Mark Emerson decided more recently to invest some of his retirement savings into annuities. Emerson, 65, of Watertown, N.Y., retired last November from FedEx after a 40-year career as a diesel truck mechanic

He says he consulted with a financial planner who put his financial details into a spreadsheet and helped him chart out his priorities and needs. 

Emerson says he got two pensions from FedEx, one of which he received in a lump sum that he used to buy an annuity. He also more recently took some money from his 401(k) and bought another annuity. Altogether, he estimates he has $400,000 in annuities to supplement his pension, real estate investments and Social Security to support him and his wife in their retirement. 

“I've never been rich and I've also never wanted for anything,” Emerson says. “I mean, I've worked all my life and if I can retire and  have the same income and maintain the same lifestyle, that's all I want. That’s exactly what I’m doing.”

The higher interest rates means his annuities pay him more, says Emerson, but that wasn’t the deciding factor. He was mainly concerned with their ability to provide reliable income. Confusing options

One aspect of annuities that makes them both appealing and intimidating is they come in many different kinds, which means they can be tailored to the buyers’ needs, but also that they can be confusing and can carry varying fees. 

To start, there are immediate annuities and deferred annuities. This refers to when you collect your payout in relation to when you give the insurance company the money. As a rule, with an immediate annuity, you are paid within a few weeks, and generally less than a year after paying for the annuity. A deferred annuity pays you later. 

There are variable, fixed and indexed annuities. This refers to  how your principal is invested. Fixed annuities generally pay a set interest rate, while variable and indexed annuities are connected to other investments or market indexes.

By far, the most popular kind of annuity is the fixed-rate, deferred annuity, which pays an agreed-upon interest rate. According to LIMRA, these annuities accounted for $165.9 billion in sales last year, compared to indexed annuities, which saw $95.9 billion in 2023 sales. 

Caution advised

Unlike most other financial investments, annuities are issued by insurance companies. And, depending on the type, they are generally regulated by the states, rather than by the federal government. Funds in annuities are not insured by the FDIC, but are protected by state guaranty associations, which protect insurance.

Consequently, experts advise checking the financial health of insurance companies before investing in their annuities.

Hauptman, of the Consumer Federation of America, says some annuities may not be a good deal.

“A lot of annuities I have significant concerns about,” Hauptman says, “particularly the more complex annuities with a lot of moving parts that are recommended and sold by financial professionals who have significant conflicts of interest in the transaction, meaning they make more money by selling an annuity relative to other investments.”

Hauptman recommends investors ask financial professionals about these conflicts involving both financial and non-financial incentives they may receive for selling particular products.  

“They can get higher commissions for recommending annuities and selling annuities, and they can also get non-cash compensation like trips to exotic locations for selling a certain amount of premiums and all of these conflicts of interest create misaligned incentives that can harm retirement investors and with less money in retirement.”

Hauptman says Investors considering annuities should know the ones that are simpler, with fewer rules and provisions, such as fixed-rate deferred income annuities, are generally a better deal. The more complicated ones, such as registered index-linked and fixed indexed annuities, can be more costly, meaning you spend more to get less return. 

Some consumer advocates advise people to steer clear of annuities altogether. Minnesota Attorney General Keith Ellison, for one, says annuities are  “unsuitable investments for seniors.” He warns on his office website that some “unscrupulous sellers use high-pressure sales pitches, seminars, and telemarketing. Beware of agents who ‘cold call’ you, contact you repeatedly, offer ‘limited time offers,’ show up without an appointment, or won’t meet with you if your family is present. Beware of estate planning ‘seminars’ that are actually designed to sell annuities. Beware of seminars that offer free meals or gifts. In the end, they are rarely free. Beware of agents who give themselves fake titles to enhance their credibility.”

Moreover, he notes that annuities often have high surrender charges, which involve a percent of the principal investment consumers forfeit if they withdraw funds early. “For instance, one of the insurance companies that the attorney general’s office sued charged a retired farmer on a fixed income $6,800 in surrender penalties when he needed access to his $24,000 (most of his net worth) placed in annuities.”

Industry reforms cited 

Harris at the Alliance for Lifetime Income says much of the general criticism of the annuity industry is unwarranted. 

“The industry has changed so much,” he says. “We've managed, over the last six or seven years. to really help the consumer understand the value of annuities because there's a lot of misconceptions. So there's a lot of people who say, ‘Oh, never buy one; they're too expensive. The guy that sells it to you is a crook.’ In the past, there's been bad actors in every industry. But the laws have changed. There's a lot of change; the industry itself has changed, and, and my adviser wouldn't make any more profit or commision off of selling me an annuity then if I wanted to buy stock, I don't worry about that.”

Navigating options 

The names of the various types of annuities can be unwieldy, which has resulted in an alphabet soup of acronyms. 

Here’s a cheat sheet with examples of popular annuities to illustrate this challenge with definitions provided by LIMRA:

• MYGA: A multi-year guaranteed annuity, which is similar to a certificate of deposit issued by an insurance company.
• RILA: A  registered index-linked annuity is a variable annuity that offers an investment option linked to a specific index.
• QLAC: A qualified longevity annuity contract, which is a type of deferred income annuity funded with an investment from qualified retirement savings, such as in an IRA.
• SPIA: With a single premium iImmediate annuity the guaranteed stream of payments begins within one year of purchase. 
• DIA: A deferred income annuity is sometimes referred to as a deferred payout, longevity annuity or advanced-life delayed annuity. This type of annuity pays a benefit to the policyholder starting more than one year from the policy date if he or she survives to a pre-established future age.

Some annuities are regulated by the federal Securities and Exchange Commission, while others are state regulated. Specifically, variable annuities are regulated by the SEC because they’re considered securities. An indexed annuity may or may not be a security. One that is a security and SEC-regulated is a registered index-linked annuity. Fixed annuities are not considered securities and are not regulated by the SEC.

Then there are different add-ons or riders that can provide protection for income or principal or beneficiaries, as well as long-term care and inflation. One category of annuity provision that has its own alphabet soup of options is the guaranteed living benefit:

• Guaranteed lifetime withdrawal benefit (GLWB): This benefit guarantees that owners can make withdrawals, subject to a specified maximum percentage per year, that will equal at least a certain minimum (e.g., premiums paid less withdrawals) or for life.  
• Guaranteed minimum accumulation benefit (GMAB): This benefit entitles the contract owner to receive a minimum amount, equal to some percentage of premiums received less withdrawals, at a specified future date (i.e., maturity). 
• Guaranteed minimum income benefit (GMIB): This benefit allows the contract owner to receive lifetime income based on a guaranteed amount and annuity rates specified within the benefit, at or after maturity. Owners must choose to annuitize after benefit maturity to use the benefit. 
• Guaranteed minimum withdrawal benefit (GMWB): This benefit guarantees that owners can make withdrawals, subject to a specified maximum percentage per year, equal to at least a certain minimum (e.g., premiums paid less withdrawals). Owners are not entitled to lifetime withdrawals under this benefit. Typically, this benefit has no waiting period. 
•  Hybrid GLB: Includes all GLBs that combine two or more of the above GLB types (e.g., GMIB/GMAB combination) within a single fee or cost.

Note: This item first appeared in Kiplinger Retirement Report, our popular monthly periodical that covers key concerns of affluent older Americans who are retired or preparing for retirement. Subscribe for retirement advice that’s right on the money. 

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