Higher interest rates are making annuities of all stripes more attractive, allowing buyers a chance to protect their principal and lock in yield before payouts decline.
Sales of the insurance product hit a record in 2023 as the combination of volatile equity and bond markets and higher payouts propelled buyers to seek annuities, says Bryan Hodgens, head of LIMRA research, an industry group.
A lot of annuities with high annual fees and costly surrender charges were sold in the past, and the product still has a bad reputation with many consumers and financial advisors. Experts say that annuities have become more consumer friendly in recent years as insurers lessened fees, shortened surrender periods and offered more flexible options on withdrawals. And third-party websites are making it easier for do-it-yourself investors to comparison shop and buy income annuities.
“You’re seeing more and more companies that are embracing this idea of providing annuities that are in the best interest of the consumers,” says Michael Finke, professor of wealth management at the American College of Financial Services.
Annuities can offer lifetime income benefits for retirees, but they still require that buyers lock up a portion of their savings as a trade-off for that guarantee. You need to read the fine print carefully before you buy one to avoid problems down the road.
The most popular annuities sold last year were multiyear guaranteed annuities, known as MYGAs, Hodgens says, giving bank certificates of deposit a run for their money. Terms for these basic annuities range from two to 10 years, with three-to-five-year terms most common, he says. Rates fluctuate, but they tend to have yields roughly a percentage point above similar-length bank CDs, with tax-deferred gains.
Finke says the higher interest rates also make traditional income annuities such as single premium immediate annuities, known as SPIAs, and deferred income annuities, or DIAs, more attractive versus a few years ago. SPIAs start paying annuitants right away, while DIAs start paying at a future date. In both cases, you can’t get your money back after you purchase one. Instead, you get regular monthly payments until you die.
The increase in payouts because of higher interest rates is significant. Kelli Hueler, CEO of Hueler Companies, says the monthly payout in October 2020 for a 65-year-old male who bought a $100,000 single life only annuity was $495. The monthly income payout for the same annuity is now $640.
Some annuitants are exchanging their older, lower-yielding MYGAs for similar ones to capture today’s higher rates, says Jamie Awe, senior annuity specialist at Baird. That can be done tax-free if certain conditions are met.
Financial advisors say they often use annuities as a way to bridge a gap between a client’s savings and expenses, rather than making it the main component of a client’s financial plan. Because annuities are illiquid, they limit the product’s portfolio allocation, says Kris Whipple, partner and financial advisor at Kristopher Curtis Financial.
“To have someone put 80% of their savings in an annuity is just a bad play,” he says.
Whipple uses fixed-index annuities, or FIAs, which were second to MYGAs in sales in 2023.
A FIA’s annual interest credit is determined by the performance of an index, such as the S&P 500, with a predetermined cap on gains, usually 6% to 8% annually, although these can vary by company, interest rates and other factors. FIA annuitants will share in the gains of the index, but if the index falls, they don’t lose money that’s already been credited to the account.
The FIAs Whipple uses have had average returns of 7% to 11% annually, and his clients may opt for additional products like income riders. The fees are usually 1% annually and come out of the accumulation value.
Rob Burnette, financial advisor and professional tax preparer at Outlook Financial Center, also uses FIAs, considering it a conservative way to create growth while protecting downside.
“If I’m looking for lifetime income, that’s the primary reason I’ll use it,” Burnette says.
Annuity costs will vary depending on the product, with the costs baked into the quote for fixed-rate income products like MYGAs, SPIAs and DIAs. FIAs, registered index-linked annuities or variable-rate annuities often have annual costs paid by the annuity itself.
It is important to review surrender charges, fees and the different riders and options available to add to the annuity. Options add cost, but can offer some flexibility, such as the ability to make small withdrawals without triggering surrender charges.
Most annuities are still sold through financial advisors, but do-it-yourself investors can visit several clearinghouses for insurer quotes and to purchase simple income annuities including Income Solutions, ImmediateAnnuities.com, Blueprint Income, a subsidiary of MassMutual. They offer guidance and education on the products. Schwab and Fidelity also offer annuities.
Unlike bank CDs, annuities aren’t guaranteed by the federal government, though they are backed by state insurance pools. Hueler recommends that annuity shoppers research the financial ratings of insurers, years in business and organizational size as part of their due diligence. Many of the websites that give annuity quotes also give financial ratings for the insurers selling them.
She says annuities shouldn’t exceed 50% of a portfolio because of their illiquidity and 20% is a more common allocation. “You should ask yourself, ‘Is this amount of (money) I want allocated to an illiquid portion of my portfolio in return for a guarantee? Am I comfortable with that,’” she says.
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