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Consumers pump money into annuities as stock market crashes and interest rates rise increase payments for buyers.
Annuity sales in the third quarter of 2022 approached $80 billion, narrowly surpassing the record high of $79.4 billion set in the second quarter, according to estimates released by insurance industry trade group Limra. .
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Consumers are poised to purchase nearly $300 billion in annuities in 2022, which would easily surpass the $265 billion purchased in 2008, the current annual record, said Todd Giesing, assistant vice president of Limra Annuity. Research.
As during the financial crisis of 2008, purchasing decisions seem largely driven by fear of stock market volatility and possibility of recession.
The S&P 500 stock index firmly entered a bear market in June, and is still down almost 19% in 2022 on Wednesday afternoon. An investor holding US bondswhich typically acts as a ballast when stocks are low, has lost nearly 16% over the past year.
Meanwhile, the Federal Reserve is trying to cool the economy by increase in borrowing costs, aimed at controlling high inflation; some economists believe that the central bank can go too far and tip the United States into a downturn.
“In difficult times, people worry about safety,” said Lee Baker, certified financial planner and founder of Atlanta-based Apex Financial Services. Baker is also a CNBC member Advisory Board.
But annuities may not be suitable for everyone, according to financial advisers.
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Buyers are looking for “downside protection”
There are many types of annuities. They generally fulfill one of two functions: as an investment or as a quasi-retirement plan providing lifetime income in retirement.
Insurance companies, which issue annuities, offer buyers guarantees that cover risks such as market volatility or the danger of outliving savings in old age.
All categories of annuities benefit from higher interest rates, which generally results in a better return on investment for insurers.
But lately, consumers have been pumping record money into two categories: fixed rate deferred annuities and indexed annuities, according to Limra data.
Fixed rate deferred annuities work like a certificate of deposit offered by a bank. Insurers guarantee a rate of return over a fixed period, perhaps three or five years. At the end of the term, buyers can get their money back, turn it into another annuity, or convert their money into an income stream.
Indexed annuities hedge downside risk. They are linked to a market index like the S&P 500; insurers cap profits on the upside when the market is doing well, but set a floor on losses if it crashes.
The average age of indexed annuity buyers is around 63, suggesting many are worried about the prospect of losing money as they approach retirement age, Giesing said.
“Anything that’s protection-based and has some downside protection is doing very well,” Giesing said of the sales.
Meanwhile, consumers are turning away from variable annuities, whose performance is generally directly tied to the stock market. Sales are on pace for their lowest year since 1995, according to Limra.
How to know if an annuity is right for you
Financial advisors often recommend using a different type of annuity when developing financial plans: a single premium immediate annuity or a deferred income annuity.
These are for retirees looking for guaranteed, pension-like income every month for life. Payments from immediate annuities start right away, while those from deferred income annuities start later, perhaps in a retiree’s 70s or 80s.
These payments, along with other guaranteed sources of income like Social Security, help ensure that a retiree has cash to cover necessities (mortgage, utilities, food, etc.) if they live a long life and their investments are depleted or dwindling.
“Am I worried that the client is running out of money? If so, that’s when I think of an annuity,” said Caroline McClanahancertified financial planner and founder of Life Planning Partners, based in Jacksonville, Florida.
McClanahan, a CNBC advisory board member, does not use single premium immediate annuities or deferred income annuities with clients who have more than enough money to live comfortably in retirement. Annuities become more of a preference for those in the middle, who will likely have enough but not necessarily; for them, it’s more of an emotional calculus: will having more guaranteed income provide peace of mind?
“A lot of people don’t understand the limits”
Of course, different categories of annuities come with tradeoffs.
Single premium immediate annuities and deferred income annuities are relatively simple to understand compared to other categories, advisers said. The buyer pays a lump sum to the insurer, who then guarantees a certain monthly payment to the buyer now or later.
They too offer retirees the best value for money compared to other types, according to advisors and insurance experts.
This is because they don’t come with bells and whistles that cost buyers money. For example, consumers can buy variable and indexed annuities with certain features – called “guaranteed living benefits” – that allow buyers to opt for a lifetime income stream or cash if they need cash. or no longer want their investment. These benefits usually come with restrictions and other fine print that can be difficult for consumers to understand, advisers said.
“The fancier the annuity, the higher the underlying fees,” McClanahan said. “And a lot of people don’t understand the limits. It’s important to know what you’re buying.”
In contrast, consumers cannot recover the principal when purchasing single premium immediate annuities or deferred income annuities. That’s likely one of the reasons consumers don’t buy them so readily, despite their income efficiency, Giesing said.
The fancier the annuity, the higher the underlying fees. And a lot of people don’t understand the limits. It is important to know what you are buying.
Caroline McClanahan
certified financial planner and founder of Life Planning Partners
Quarterly Single Premium Immediate Annuity sales hovered around $2.5 billion, and consumers are buying about $500 million to $600 million in deferred income annuities, Giesing said — about one-tenth and one-fiftieth, respectively, of the nearly $30 billion in sales of fixed deferred annuities in the third quarter.
From a behavioral perspective, protection-focused annuities can make sense for someone five to ten years from retirement who can’t handle the volatility of investments and is willing to pay a slightly higher cost for retirement. stability, Baker said.
But Baker warned that the value proposition probably no longer makes sense to investors. This would effectively lock in large losses on stocks and bonds and then cap gains on the upside for the life of the insurance contract, he said. Investors can now earn a return in excess of 4% on safe-haven assets such as shorter-dated US Treasury bonds (a 3 months, 1 year and 3 yearsfor example) if they hold these bonds to maturity.