Yep. Right on cue.
As stocks, bonds and other investments have tanked, ordinary investors have flooded into higher-fee annuity products in the quest for investments with more “safety” or “protection.”
One of the many reasons ordinary investors underperform the market over the long term is that so many tend to flee stocks after things have slumped. They won’t get excited about the market again until it’s back up.
LIMRA, a trade association for the insurance industry, reports sales of annuities have skyrocketed this year.
Overall annuity sales jumped an astonishing 29% in the third quarter from a year earlier, hitting a record $81 billion, LIMRA reports. So far this year sales are up 17% to $224 billion.
Annuities are financial products produced by insurance companies, and they are a kind of hybrid of insurance and investment. They actually come in so many different kinds, including “fixed rate deferred annuities,” “fixed indexed annuities,” “registered indexed linked annuities,” and so on.
Annuities certainly aren’t all bad. They can, for example, allow you to invest while sharing some of the risks with the insurance company selling you the product. They can also let you build a life insurance tax shelter around long-term investment returns. (It’s not as exciting as it may sound, as you will eventually pay higher ordinary income-tax rates on your gains, instead of lower capital-gains tax rates, but there can be some real benefits.)
But insurance companies do not sell these products below cost, or out of the kindness of their hearts, and life insurance industry costs are rarely trivial. One way or another, customers pay, and they often end up paying a lot. The cost comes in the form of lower returns.
They also have the problem that in many cases the insurance companies, for (sound) regulatory reasons, invest your annuity premiums in “safe,” investment grade corporate bonds. As those bonds have historically produced much lower returns over the long term than the stock market, the amount they can pay you is going to be pretty limited.
In many or most cases, customers are probably going to be better off investing their money directly in stocks or corporate bonds, either individually or through low-cost funds.
Yes, annuities are paying much higher interest rates than they were a year ago. But that’s because bond yields are up. You can always just buy the bonds.
The current boom encompasses such products as fixed-rate deferred annuities, which are a tax-efficient savings product a bit akin to a certificate of deposit, and fixed and equity indexed annuities, where you get a rate of return tied to the performance of an index, using a stock market index. If the stock market goes down your downside is limited. But if the stock market goes up your annual gains are typically capped.
Many financial planners are critical of the products.
“I never recommend index-linked or any kind of indexed annuity,” says Delia Fernandez, a financial adviser in Los Alamitos, Calif. She adds: “There’s too little that goes to the investor, too much to the insurance firm. The investor thinks they’re getting much more of the upside than they actually receive, not realizing how much the insurance industry caps that upside, and on top of that, the buyer doesn’t receive any of the dividends.”
On the other hand, some fixed rate annuities have specific uses. Howard Pressman, a planner at Egan, Berger and Weiner in Vienna, Va., says fixed annuities are savings vehicles that can be valuable to higher earners because of the tax deferral on interest.
But, he says, when it comes to all annuities, “the questions I always encourage people to ask their adviser is ‘what need do you see this annuity fulfilling in my financial plan?’ and ‘what other strategies did you consider for me and why do you feel this one is best? ‘”
He adds: “Beyond that, make certain you understand the fees associated with the annuity, how you will access your money, how long the contract lasts and how the person selling you this annuity is being paid.”
Arguably the most useful annuities are those that let you convert a lump sum into a guaranteed income for life. These “single premium immediate annuities” allow individuals to insure themselves against the risk of outliving their money, effectively converting a pile of cash into a lifetime pension. (Failure to annuitize retirement income is among the more common financial regrets of the elderly.) Ironically, these annuities tend to be among the least popular in the market, and account for only a tiny fraction of the entire industry.