Over the past year or so, annuities have gained considerable attention as investors have become wary of the volatility in the market and the rising interest rates. In 2022, annuity sales reached record highs, soaring to $80.7 billion in the third quarter alone. It’s projected that the overall annuity market will expand to $298.7 billion by 2026.
But what precisely are annuities, and what makes them such an appealing option for your portfolio? Read the following insights from our team at Premier Planning Group to learn what role they play.
What Is an Annuity?
An annuity is simply insurance or protection on your money. When you buy an annuity, you are buying an insurance product that pays out a stream of income either for a set period of time or for life. Similar to other insurance policies, you sign a contract with an insurance company where you agree to pay a premium amount (either lump-sum or monthly payments). These funds are then invested by the insurance company and paid out to you at some point in the future.
An annuity essentially functions as insurance against the risk of outliving your retirement funds. Annuity income is guaranteed based on the terms of the contract and will be paid out even if the underlying investments do not perform well or the account is depleted early.
There are three main types of annuities:
- Fixed: Guarantees a minimum interest rate and a fixed number of payments for a set period of time.
- Variable: Allows the purchaser to choose different investment options which yield higher or lower returns based on performance.
- Indexed: Pays a capped interest rate based on stock market indices like the S&P 500 or NASDA8.
Why Are They So Popular?
Annuity sales have skyrocketed in 2022, in part due to the uncertainty in the stock market. Rising interest rates and volatile stock performances have investors flocking to safer investments like certificates of deposit, money market accounts, U.S. Treasuries, and annuity products.
Here are some of the benefits an annuity can provide:
1. Guaranteed Income
The guaranteed income element is one of the biggest advantages of an annuity. If you’re worried about outliving your money in retirement, an annuity ensures you have supplemental income for the rest of your life, or for whatever time period is stipulated in the contract. There are many different types of annuities on the market, so the exact amount and number of payments you’ll receive may vary. Before you buy an annuity, it is crucial that you understand the terms and conditions.
2. Protection From Downside Risk
Annuities insure against downside risk and can provide a buffer against stock market volatility. If you purchase an annuity that has a fixed interest rate of, say, 8% you are guaranteed to earn that much regardless of how the stock market actually performs. This can be a huge relief during times of extreme market volatility as we’ve seen over the last year. The downside? If there’s a cap on your interest or you have a fixed rate, you won’t be able to take advantage of the upswing if the stock market returns more than 8%.
3. Tax-Deferred Contributions
When you contribute money to an annuity, it grows tax-deferred. You won’t pay taxes on the investment growth until you start receiving payments. Depending on your contract’s interest rate, your account value could grow substantially from the time you invest funds to the time you withdraw.
Important Considerations
Though the advantages of annuities make them very attractive in the current market environment, they are not for everyone. There are still several important considerations to keep in mind before deciding if an annuity is right for you.
1. Complexity
There are a vast number of annuity products on the market today with a wide range of complexity. As a general investing rule, never purchase a financial product you don’t fully understand. Look for insurers who have been in business for a long time and have “A” ratings or better for financial strength.
Unlike funds deposited in banks or credit unions, annuities do not have federal protection if the insurer goes bankrupt. States provide some protection, but it varies depending on where you live. The state of Maryland has a Life and Health Insurance Guaranty Corporation that provides protection for policy holders. For annuities, if you live in Maryland, the protection is $250,000 in the present value of annuity benefits, including net cash withdrawal values and net cash surrender values.
2. Limited Liquidity
Most annuities, in exchange for protecting principal, require you to give up liquidity for a period of time. The range is usually about five years on the short end and ten years on the higher end. Most also, however, allow you to have access to a percentage of your annuity within this surrender charge period, and the amount is usually 10% per year from most annuities of the amount contributed. For example, if you invested $100,000, you would be eligible to withdraw up to $10,000 per year for the length of the contract, penalty free.
3. Taxed As Ordinary Income
When you withdraw money from an annuity, or begin receiving income payments, any pre-tax funds and earnings will be taxed at your ordinary income tax rate similar to a traditional IRA. When you withdraw funds from a taxable investment account, it’s usually taxed at the long-term capital gains rate if the investment was held for at least a year. For most people, their ordinary tax bracket is higher than their capital gains tax bracket.
There are seven ordinary income tax brackets ranging from 10% to 37% depending on income and filing status. There are only three long-term capital gains tax brackets:
Single Taxpayers | Married Filing Jointly | Capital Gains Tax Rate |
$0 to $44,625 | $0 to $89,250 | 0% |
$44,626 to $492,300 | $89,251 to $553,850 | 15% |
$492,301 or more | $553,851 or more | 20% |
Simply put: If your income tax bracket is too high, it could eat away your annuity earnings.
Does An Annuity Fit In Your Financial Picture?
Acquiring an annuity is a significant decision that demands careful consideration. It involves understanding the product’s terms and conditions and analyzing your entire financial status. At Premier Planning Group, we are committed to supporting you in making the best decisions for your portfolio. If you have questions regarding your present financial circumstances or desire to explore how annuities can contribute to your retirement plan, we’re happy to assist you! Contact us by calling our office at (443) 837-2520 or email my executive assistant, Talia Grover, at taliagrover@premierplanninggroup.comto set up a complimentary consultation.
About Brion
Brion Harris is the CEO, founder, and managing partner of Premier Planning Group, an independent financial firm specializing in working with pre-retirees and retirees, helping them create customized wealth preservation and retirement distribution strategies. With over 20 years of experience, Brion has developed deep knowledge and skill in helping his clients simplify their finances and find confidence in their financial future. Brion and the Premier Planning team are known for their unparalleled client service and their dedication building long-lasting relationships with their clients. As a result, Brion has been the recipient of the #1 Advisor Leadership Award* at Summit Brokerage Services for eight years running and has a reputation as one of the top retirement advisors in the business.
Brion is a proud 20-year resident of the Annapolis community, where he resides with his wife, Elizabeth, their three children, Addison, Jay, and Scarlett, and their two dogs, Pepper and Coco. When he’s not working, you can find him boating, skiing, traveling, and enjoying good food and music with his family. If you want to learn more about Brion, connect with him on LinkedIn.