Are annuities getting a new lease on their polarizing image?
The complicated insurance products have long been divisive as an investment strategy. Proponents argue they can safely beef up an aging worker’s retirement portfolio and provide reliable income in later decades. Critics call them a bad investment that’s aggressively marketed by commission-hungry advisors and cheesy infomercials.
Either way, specific breeds are surging in sales. The winners? Contracts that are tied to stock market indices and known as registered index-linked annuities, or RILAs. In second place are so-called fixed-rate deferred contracts that guarantee a minimum interest rate for a later period of time — sort of like a certificate of deposit — but then may adjust. Taken together, their recent surge suggests that investors accustomed to hefty stock market returns in recent years and annoyed by low yields on bonds and Treasuries are willing to shoulder a bit more risk with their retirement planning.
Annuity products “are shifting from guaranteed income, which is the old model, to more of an accumulation side, which is what [ investors ] are accustomed to in their wealth models,” says Nicholas Ross, the chief distribution officer at Financial Independence Group, a marketer of insurance to agents and brokers. He’s referring to years in which an investor adds money to her annuity, which then grows in value. He says investors “are looking for alternatives to this roaring bull market and the loss of bond markets.”
Which may explain why annuities with a bit more downside risk than the traditional ones your parents or grandparents bought — the old-school variety that immediately pays set sums — are becoming more popular. Sales of RILAs and fixed-rate deferred annuities, which make their payouts years later, over the first three months of 2021 propelled the overall industry to its strongest annual start since 2009, according to Todd Giesing, the director of annuity research at LIMRA, an industry-funded trade group.
Sales of RILAs, which let investors set the peak loss they’re willing to suffer, totaled $9.2 billion in the first three months of 2021, an 88% surge on year-ago levels, LIMRA
With so many varieties and so much confusing jargon, the annuities industry can be opaque, and different experts track different numbers.
The point is that RILAs show that “the big takeaway is that the game is changing and evolving,” says Ross. “It’s been a long time in the making, but it’s happening pretty quickly.”
Perceptions of risk
The COVID pandemic pretty much T-boned industry sales last year, so the recent surge is picking up lost ground.
“This is an industry that is very much built around in-person sales,” says Ramsey Smith, the founder and CEO of ALEX.fyi, an online agency for income annuities. “Last year, the world went totally virtual. The process of prospecting, educating clients, closing a sale through a Zoom paradigm was a very sudden change that the vast majority of folks, advisors and customers just weren’t ready for.”
Annuities aren’t technically investments but insurance contracts. They’re not taxed until they pay out money to their owners. Poorly understood by most consumers and advisors, they can sometimes seem like a multi-dimensional poker game. Smith calls them “really, really hard to sell” due to their complexity.
Individuals who buy them owe tax only when they receive periodic payments or lump sum distributions, at ordinary rates now topping 37%. There’s no access to the tax break for capital gains, now 23.8%. Those bought with pre-tax dollars from an IRA or a 401(k) are deductible on federal returns. While those bought with after-tax money aren’t deductible, they’re taxed at ordinary rates only on the growth portion.
Annuities are synonymous with stable, guaranteed income, not risk. The
Still, the contracts reflect consumer perceptions of risk. That makes them a barometer of how aging Baby Boomers can fine-tune their thinking about what they need to live comfortably in retirement. And so the trend of growing sales of contracts with a bit of risk baked in points to a subtle shift in how investors are thinking about their financial futures.
“Last year, people’s focus changed,” Giesing says. “They weren’t focused on long-term retirement plans; they were focused on how to go get toilet paper and groceries during the pandemic.” On the economic front, historically low interest rates have pummeled the market for annuities tied to immediate, fixed payouts. The Federal Reserve’s benchmark rate is near zero, which has
The big picture is that “investors have return goals that don’t go away, so they have to take more risk to get the same outcomes,” says Ramsey, a former Goldman Sachs executive. “RILAs have more risk — it’s equity risk exposure with limited risk, with a downside buffer.”
CFP Reid Mathews, the chief operating officer of Berry Financial Group, an RIA in Myrtle Beach, South Carolina, says he’s been selling annuities as a bond alternative. “Interest rates are so low, so bonds are not paying very much, plus the potential for inflation and higher interest rates in the future brings in interest rate risk to bonds” he says. By contrast, “annuities can be positioned with absolutely no downside, yet double digit returns when markets perform well.”
This could be a big opportunity for advisors, who along with insurance agents sell almost all annuities and earn hefty commissions or fees in the process. “These are complex products. You need a professional to explain what the benefits are,” LIMRA’s Giesing says. Annuities “used to be added to the four-letter word list” but now have a better image compared to five or 10 years ago, he says: “The perception is changing.”
