Market volatility, rising rates boost annuities

If the recent market swoon has made you nervous about your retirement funds, an annuity may help calm your nerves and protect you against giant swings in the market if used right, some financial advisers say.

That's likely why annuity sales are soaring. Second-quarter sales are projected to top $74 billion, setting a record, according to life insurance industry-funded research firm LIMRA. That would be more than $5 billion above the previous record set during the financial crisis in the fourth quarter of 2008.

Record sales are being driven by fixed-rate deferred annuities, which are expected to be between $25 billion and $30 billion, up almost 75% from the first quarter. They work much like CDs, offering investors a fixed interest rate on their money over a certain period, but the interest rate on an annuity is generally higher than on a CD.

"There's almost a perfect storm right now," said Todd Giesing, LIMRA head of annuity research. "Rates are rising so you can earn more on these, and on top of that, the equity market is volatile. People are seeking safety and guaranteed rates."

Variable and indexed are the other two major types of annuities that make up most of the balance of annuity sales. Fixed annuities are considered the safest because you can't lose the principal, and variable annuities are seen as the riskiest because they move in step with markets. An indexed annuity is considered somewhere in the middle.

What are annuities?

They're contracts with insurance companies to pay you regularly, starting right away (immediate) or in the future (deferred). You can buy an annuity for as little as $10,000 in a lump sum or regular periodic payments called premiums.

A guaranteed lifetime income benefit option also "can be great if you're worried you might outlive your savings as they can provide guaranteed income for the rest of your life, whether you live to be 100 or even 120," Adam Politzer, Athene senior vice president of Product Actuary, said.

Some also have a death benefit so if you die before collecting on the annuity, your heirs get the amount you contributed, plus investment earnings, minus whatever cash withdrawals you made.

"We often sell annuities to younger clients that have a long-term investment horizon who want to build their retirement savings on a tax-deferred basis," he said. "We also often sell to recent retirees who want to ensure that they don't outlive their savings."

What are the benefits

of a deferred annuity?

Deferred annuities, sometimes called "longevity insurance," ensure there's enough money to fund late-stage retirement.

They're good for long-term retirement planning because earnings aren't taxed until you begin making withdrawals or are receiving periodic payments, although withdrawals before age 591/2 may be subject to an additional 10% tax.

Unlike a 401(k) or an IRA, there are no limits on your annual annuity contributions. "If you're already contributing the maximum to other retirement plans, like an IRA or 401(k), an annuity can be an attractive option to continue saving in a tax-deferred way," Politzer said.

What are the benefits

of an immediate annuity?

With these, you can invest a lump sum into an annuity and start taking payouts immediately to supplement your current income. You also only pay taxes on the portion of your immediate annuity payments that are considered earnings, not the principal, or the initial deposit made with after-tax money.

What are the three main types of annuities? Once you've decided whether you want a deferred or immediate annuity, consider what you want from your annuity. A fixed annuity guarantees you will earn a specific interest rate on your investment and receive a fixed payout.

A variable annuity works similarly to a 401(k), allowing you to choose investments – called here "separate accounts" – that resemble mutual funds. Returns and payouts vary with financial market moves. However, they can offer death benefits, and payout options guaranteeing lifetime income and fees can be much higher. An indexed annuity is kind of a hybrid of fixed and variable. It's pegged to an index like the S&P 500, offering a minimum guaranteed interest rate (like bonds) and a payment linked to a market index (like equities). However, losses based on market indexes are limited. In exchange for that safety, potential gains are also capped. Between the two, the band the annuity can move within is narrower than the market's, meaning less volatility.

Are there any downsides?

For one, they can be expensive.

The Securities and Exchange Commission warns of the various fees on variable annuities, for example. Some include surrender charges if you cash out early, administrative fees, underlying fund expenses charged by the mutual funds you might have invested in, and other charges related to features like long-term care insurance you choose to add on. Variable annuities also move in line with markets so they wouldn't offer much protection in a downturn.

Fixed annuities don't adjust for inflation, which could erode your return. With a fixed rate, you also risk losing out on sharply higher rates, as people are expecting this year if you lock in now.

Insurance companies price them so you must take their word and trust the company remains solvent. State insurance commissions, not the Federal Deposit Insurance Corp., regulate and guarantee them. So, check with the state insurance commissioner to ensure the broker is registered and authorized to sell annuities in the state.

Are annuities worth it?

"They can all be beneficial if used properly," Josh Simpson, vice president of operations and investment adviser with Lake Advisory Group in Lady Lake, Florida, said. "No one should put all their money in an annuity. Everyone should diversify. But if you have no annuity and all your money in IRA, maybe consider one."

But like everything else, make sure you read the fine print. Annuities can be complex and include a lot of fees that need to be considered.

"Look closely at what the rules are regarding them," Simpson said. " And don't talk to an insurance company to buy one. Talk to an independent insurance agent and ask if they're a fiduciary. If they say yes, then go talk to them. The first consultation shouldn't cost any money."