Annuities – What Are They?

An annuity is a contract between a buyer and an insurance company, where the buyer receives a regular series of payments in exchange for a lump-sum payment. Unlike a brokerage account, IRA, or savings account—which offer more liquidity—annuities provide unique benefits such as tax deferral and more predictable returns.

Are They Safe?

Absolutely. Annuities are often backed by mutual insurance companies with balance sheets so robust they're the envy of major banks. Regulators mandate that insurers maintain sufficient surplus to support the policies they issue. Many insurance companies boast cash surpluses so high that they provide peace of mind for decades. Credit rating agencies reflect this stability in their ratings.

Types of Annuities: Fixed, Variable, or Indexed?

Fixed Annuities –

As in their name offer fixed returns for a fixed number of years, which may suit some people more than a variable-rate savings or money market account. They are ideal in a high-interest rate environment, like 2024, where you can lock in a rate of 5.5% for seven years. If interest rates drop to 2.75% in two years, you'll continue to enjoy the higher rate for the remaining five years. It would be like refinancing your mortgage at a lower rate but in reverse. While you won't have full liquidity, you'll have partial access to your funds.

Variable Annuities -

Allow you to allocate your investment to a series of mutual funds, building a portfolio within the annuity across different asset classes. They come with dual levels of fees that can impact returns, so careful selection by the client and advisor is crucial. Variable annuities are considered investment securities and are regulated by the SEC and FINRA.

Indexed Annuities -

Generally track stock market indices like the S&P 500. They offer a 0% floor in negative years, protecting you when the market drops by 20%. However, they cap your gains at 9% in positive years, even if the index rises by 30%. This approach smooths out market returns, making it an attractive option for risk-averse individuals looking to grow their assets without the stress of potential losses. Indexed annuities are particularly suited for cautious clients approaching retirement but still a few years away from it.

Is an annuity for you?

It depends on your time horizon, potential liquidity needs, how risk averse you are, stage of life, current tax bracket and the prevailing economic conditions.

If all the pieces fit, annuities can be a great safe solution for medium to high single digit returns in a tax deferred vehicle.

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