As the world continues to navigate uncertain economic times, securing a steady and reliable source of income for retirement has become increasingly important to those approaching their golden years. Annuities, a financial product that offers guaranteed income for life, have become particularly attractive to individuals looking to pursue financial freedom. The sales of this financial product hit record highs in 2022, reaching 80.7 billion in the third quarter, with the annuity market predicted to grow to $298.7 billion by 2026.
Let’s explore why annuities are gaining popularity in today’s economy and discuss the benefits they can provide for retirement planning.
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.
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.
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).
Married Filing Jointly
Capital Gains Tax Rate
$0 to $44,625
$0 to $89,250
$44,626 to $492,300
$89,251 to $553,850
$492,301 or more
$553,851 or more
Simply put: If your income tax bracket is too high, it could eat away your annuity earnings.
We Can Answer Your Questions
Acquiring an annuity is a decision that requires a deeper understanding of the product’s terms and conditions, in addition to a detailed assessment of your overall financial circumstances. At T.A. Holland & Co., we are committed to assisting you in making the correct choice. If you have any concerns about your present financial position or wish to explore how annuities can complement your retirement plan, we invite you to contact us! Reach out to us at firstname.lastname@example.org or 617-523-5656 to schedule a complimentary appointment so we can get to know each other.
Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Guarantees are based on the claims-paying ability of the issuer. Withdrawals made prior to age 59½ are subject to a 10-percent IRS penalty tax, and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available subaccount portfolios will fluctuate, so the value of an investor’s unit, when redeemed, may be worth more or less than the original value. Optional features available may involve additional fees.
About T.A. Holland & Co.
T.A. Holland & Co. was founded in Boston, Massachusetts, in 1920, and serves individuals and businesses throughout the country. We provide cutting-edge financial services with a broad array of solutions to help our clients grow and preserve their wealth. We have seen good and bad economic times. Through it all, T.A. Holland & Co. has thrived by always making the customer our #1 priority. We get to know you and understand your needs so we can provide you with the proper guidance and strategies. Our senior vice president, John Hellmuth, has been at the helm of T.A. Holland’s financial services since 1990, but he doesn’t do this job alone. He is joined by his two children, Lindsay Hellmuth and Thomas Hellmuth. As CERTIFIED FINANCIAL PLANNER™ practitioners, our financial services team has the knowledge and experience to help you solve your most pressing financial challenges. To learn more about how we can help you, visit our website and reach out to us at (617) 523-5656 to schedule a complimentary get-acquainted meeting.