By Jay Shareef and Chris Rhoads
Annuities have gained significant popularity over the last year or so as investors have shied away from rising interest rates and market volatility. In fact, annuity sales hit record highs in 2022, reaching $80.7 billion in the third quarter alone, and the overall annuity market is expected to grow to $298.7 billion by 2026. So what exactly are annuities and what makes them so attractive right now?
What Is an Annuity?
An annuity is 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 a stock market index like the S&P 500.
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, 7% 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 7%.
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.
You may even be able to invest pre-tax funds into an annuity by purchasing the product through your 401(k) or another employer-sponsored plan. This is a relatively new option that many employers are embracing, and since retirement plan providers are required to thoroughly vet insurers, this may be a better way to purchase an annuity than combing through all the options on the open market.
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. While the payout may seem promising, there could be extra fees and penalties buried in the fine print.
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. What would happen to your annuity if the insurance company goes under? Are you promised returns on optional benefits you purchase with your annuity? How much will your insurer or agent make on this product? These are all questions to consider when purchasing an annuity.
2. High Fees & Penalties
Annuities have a long-standing love-hate relationship with the investing public partly because they’re often sold by agents who receive sales commissions and management fees. In return, many clients don’t know if they’re being pushed to buy a product they don’t need. Annuities also come with many fees, such as:
- Surrender fees: You can cash out your policy—for a price. Surrender charges usually range from 7%-10% of the account balance and can be in effect for the first 10 years of the policy.
- Administration fees: Annuities also come with an annual fee, typically 0.3%, for managing and maintaining the account.
- Early withdrawal fees: Withdrawing funds before age 59.5 generally results in another 10% penalty.
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. This means you may pay more in taxes when you withdraw from an annuity than you would if your money was invested in a taxable investment account (funded with after-tax monies).
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.
Is an Annuity the Right Choice for You?
Purchasing an annuity is a decision that shouldn’t be made lightly. It requires a thorough understanding of the product terms and conditions, as well as a detailed look at your overall financial situation. At WealthFlow Financial, we are here to help you make the right choice. If you’re a federal employee with questions about your benefits package or would like to learn more about how annuities can fit into your retirement plan, we would love to hear from you! Reach out to us at (301) 798-5250 or schedule a phone call now.
About Jay
Jay Shareef is vice president, financial advisor, federal benefits consultant, and co-founder at WealthFlow Financial. As a U.S. Army veteran, Jay is passionate about helping federal employees create a bulletproof plan for retirement and navigate the often confusing and complicated federal benefits landscape. He spends his days educating and providing clients with unbiased insurance benefits and retirement strategies to help his clients create guaranteed income for life. As a problem-solver and trustworthy resource, Jay always puts his clients and their needs first so they can find financial peace of mind. To learn more about Jay, connect with him on LinkedIn.
About Chris
Chris Rhoads is a co-founder and vice president of WealthFlow Financial. As a registered investment advisor and independent financial professional, Chris is committed to helping his clients in retirement and he takes a holistic approach to financial planning that includes insurance and risk management, investments and wealth management, retirement income planning, and estate and tax planning. Chris has been married to his wife, Tia, since 2009 and they live in Frederick, MD, together with their two young daughters. In his free time, Chris enjoys traveling, watching sports, and being active in causes about which he cares passionately. To learn more about Chris, connect with him on LinkedIn.