William Lako : With high inflation and volatility, do annuities make sense?

Rising interest rates, high inflation, and a declining stock market can push many investors to question their investment selection, especially those looking at retirement in a few short years. As such, the Secure Retirement Institute reported total U.S. annuity sales are at their highest since 2008. Does it make sense to purchase annuities in times of volatility and uncertainty?

Annuities are not a financial plan but products to use inside a structured plan to minimize an identified risk. Furthermore, I look at annuities as part of or an instrument within your fixed income portfolio. The basic principle is that you pay a premium to an insurance company in exchange for future periodic payments. The payments may begin immediately or at a future date and can continue for a period that can be as long as your lifetime. Depending on the terms of the annuity, the insurance company may provide you with contractual guarantees based on the claims-paying ability of the issuing insurance company and prevailing market conditions.

Why do higher interest rates increase investors' curiosity about annuities? Payouts are based on two key factors: life expectancy and interest rates. When insurance companies can get a higher yield on their bond portfolio, they generally provide higher benefits or extended guarantees on the policies for their current policyholders but also make them more attractive to prospective buyers. It is a win-win situation for both the insured and insurer. However, insurers do not have access to investments in the market that are different from what is readily available to all investors; therefore, investors need to ask, "What does this annuity do for my plan?"

Annuities are still investments, and with all investments, there are inherent risks. Too many times investors were sold on the idea that one product could successfully accomplish the dual objectives of guaranteed income with market-oriented growth. However, when using annuities for a single purpose, they can be effective, regardless of whether the need is for guaranteed income or the "safe" growth of money.

More often than not I see existing annuities repurposed to fulfill a current need. Annuities should be measured for their "risk transfer." If an investor can transfer an identified risk for a fair return, then it is generally considered a good trade. Before you engage in any investment product, you need to know: the initial fees and ongoing fee structure; the increased costs for additional guarantees; your investment restrictions and if adding guarantees to your annuity product will reduce your investment options, and when and how to access your funds and any penalties associated with accessing funds.

Inflation can affect many investments, but you may be able to invest into a diversified portfolio of high-quality stocks from companies that can more easily pass on the higher costs to the consumers. While you are placing your trust in the stock market, you can generally manage your risk and minimize volatility by investing across numerous sectors and multiple companies within each sector.