By Bernie Wurts, CFP®

Over the past few years, annuities have seen a surge in popularity, driven by investor concerns around rising interest rates and market fluctuations. In 2022 annuity sales reached unprecedented levels, with the third quarter alone accounting for a staggering $80.7 billion in sales. Currently the overall annuity market is projected to expand to $298.7 billion by 2026. 

So, what are annuities, and what is it about them that makes them so appealing in the current financial markets? Read on to learn more and determine whether they are the right fit for you and your retirement plan.

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:

1. Fixed: Guarantees a minimum interest rate and a fixed number of payments for a set period of time. 
2. Variable: Allows the purchaser to choose different investment options which yield higher or lower returns based on performance.
3. 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: 

Simply put: If your income tax bracket is too high, it could eat away your annuity earnings. 

Helping You Make the Right Choice

Are you still left wondering if an annuity is the right decision for your finances? The process of deciding requires a careful analysis of the product’s terms and conditions, as well as a comprehensive evaluation of your overall financial situation. 

At Professional Financial Advisors, we understand the weight of this decision and are here to provide guidance so you can make the best choice for your unique needs. If you have any questions regarding your current financial standing or would like to learn more about how annuities can support your retirement plan, please do not hesitate to reach out. We’d love to hear from you. Call (913) 322-3845 or email wurts@pfaretire.com.

About Bernie

Bernie Wurts is a CFP®, Certified Financial Planner, at Professional Financial Advisors, LLC, an independent, fee-based, Registered Investment Advisory firm delivering full-service financial planning and investment guidance to families and businesses or organizations. Since 1994, Bernie Wurts has been working with individuals and business owners to help map out their retirement and succession plan. Along with a team of CPAs and estate planning attorneys, Bernie works to ensure no stone is left unturned and operates under the methodology of doing the right things today to avoid unpleasant surprises later. He enjoys making a difference in his client’s lives as they pursue a worry-free retirement, and has two goals for every client: be the kind of financial advisor whose integrity and character would be good enough for his mother and create enough wealth so they have the resources to live a life with no regrets. 

Bernie received his bachelor’s degree in business from The University of Akron and holds the CERTIFIED FINANCIAL PLANNER™ designation. Outside of the office, Bernie enjoys outdoor activities, sports, and spending time with family. To learn more about Bernie, connect with him on LinkedIn.