They say the only certainties in life are death and taxes. I’d be tempted to add one more truth to that list: Whenever there is an economic downturn, annuity sales rise.
Annuity sales for 2022 broke $300 billion, shattering the previous record set during the 2008 recession. The timing of these purchases is not coincidental. The fact is that annuities are aggressively marketed to investors during these times, and many people are swayed by the promise of safe, risk-free investment or guaranteed income stream in retirement.
Let me be clear: there is nothing wrong with annuities. For the right person under the right circumstance, they can be a powerful tool. But I do take issue with the way annuities are sometimes marketed.
It seems all too often that frightened, uncertain investors are urged to act on fear rather than a measured and principled financial strategy. And when that happens, it’s rarely the investor who profits.
What Is an Annuity?
In simple terms, an annuity protects against outliving your income. They are sold by insurance companies and can be considered as the other side of the coin to life insurance: one protects against dying too early, the other against living too long.
There are several types of annuities. You pay money into them, either in one lump-sum investment or in regular payments over time. That money is then invested, and you receive a monthly payment for the agreed-upon lifetime of the annuity, similar to a pension plan.
The rate of return may be fixed, meaning it stays the same regardless of what’s happening in the market. Or it may be variable, meaning the return is tied to market performance.
Annuities offer a contractual, predictable monthly income that can become a pillar of retirement. But as attractive as this is, it can come at a cost.
The Downside to Annuities
Annuities are considered illiquid investments, particularly in the early years of a contract, meaning once you put money into them there is no way to take it out without facing penalties. Some annuities also come with annual fees and other internal expenses. Other annuities do not have these fees, but will instead see a limited rate of return compared to other investments.
For example: An annuity might be sold with a guaranteed 2% annual return. In a down market when an investor is worried about losing money, that guarantee is attractive. When the market recovers by 20%, you still only receive that 2%. The remaining 18% becomes profit that goes directly into the pocket of the insurance company.
From that perspective, it becomes clear why annuities are such a popular product to sell to people in times of uncertainty. The insurance company can capitalize on the fear of investors, offering small, guaranteed returns or protection against losses, and then ultimately profit greatly when the market recovers. The insurance company is using your money to buy low and benefit from the recovery of the market.
Investing Without Fear
For the Spirit God gave us does not make us timid, but gives us power, love and self-discipline.
– 2 Timothy 1:7
There are situations where annuities are an excellent vehicle for retirement savings. For example, if you have maxed out your tax-advantaged investments, like your 401(k) and IRAs but have additional money you wish to set aside in a tax-deferred account, an annuity can be a great option. But many people end up buying annuities from a place of fear rather than strategy.
The reason that annuities become so popular during down markets is that they represent safety and the assurance of a guaranteed income. In times of fear, this security is very appealing. But an annuity is a long-term investment, and making decisions about the future based on short-term emotions rarely leads to the best outcome. The long-term earning potential and value over the lifetime of the investment must be considered.
Additionally, annuities are complicated, and it can be hard to know exactly what you’re getting if you aren’t examining the terms very closely. A product sold as “safe money” can still carry some risk, and we’ve often met with clients who are unaware of those risks or have limited understanding of exactly how their annuity works.
If you are uncertain about your investment strategy or have worries about where the market may lead, it’s best to meet with a financial advisor who will take the time to look holistically at your finances and develop a plan.
It may be that an annuity is a good tool for your needs. It may be that other types of investments are best for your retirement planning and other savings goals. Whatever your situation, your financial decisions should not be fear-based or driven by short-term emotions. You deserve reasoned, principled counsel that aligns with your goals and values.