The year 2023 saw an unprecedented surge in consumers investing in annuities, driven by higher interest rates and concerns regarding the stock market and the U.S. economy. According to LIMRA, an insurance industry group, Americans have purchased approximately $360 billion worth of annuities this year, surpassing the previous record of $311 billion set in 2022, which was established amidst the 2008 financial crisis. This article delves into the factors contributing to this surge and the various types of annuities available to investors.
Annuities are financial products offered by insurance companies. They involve customers depositing a lump sum of money in exchange for a guaranteed income stream for life, similar to a pension or Social Security. Financial planners occasionally recommend annuities to safeguard against the risk of outliving one’s savings. However, it is crucial to note that not all annuities are created equal, as highlighted by Carolyn McClanahan, a certified financial planner based in Jacksonville, Florida.
One significant factor contributing to the increased appeal of annuities in 2023 is the rise in benchmark interest rates by the U.S. Federal Reserve. This decision marked the highest interest rate levels in 22 years, consequently boosting the returns and income potential accessible through annuities. Todd Giesing, the head of annuity research at LIMRA, explains that despite the stock market’s recovery from a challenging 2022, many investors still grapple with uncertainties surrounding inflation and the economy. This uneasiness has driven consumers towards seeking relative safety and stability, favoring fixed-rate deferred annuities.
Fixed-rate deferred annuities operate similarly to certificates of deposit, assuring the preservation of principal while providing a fixed return over a specific period. These annuities have gained considerable popularity in recent years due to their ability to offer average rates around 4.5%, triple the 1.5% rates of just two years ago. As a result, they accounted for the majority of annuity sales in 2023, totaling an estimated $140 billion. This discrepancy between consumer preferences and financial advisor recommendations raises questions about the suitability of the annuity types being purchased.
Financial advisors often advocate for using annuities to mitigate longevity risk, guarding against the possibility of outliving retirement savings. These insurance products act as a safety net, covering any shortfall in funding necessary expenditures such as food and housing, once guaranteed income streams from Social Security and pensions have been taken into account. McClanahan, the founder of Life Planning Partners, predominantly employs single premium immediate annuities (SPIAs) with her clients. SPIAs are the simplest form of annuities, involving a lump-sum payment to an insurer, which then provides a fixed monthly sum for the remainder of the buyer’s life.
Paul Auslander, a certified financial planner and director of financial planning at ProVise Management Group in Clearwater, Florida, shares McClanahan’s preference for SPIAs when employing annuities to generate a secure income stream. Another alternative is deferred-income annuities (DIAs), which follow a similar payment structure but come into effect at a later stage. DIAs commence payment at a pre-determined point in the future, usually in a buyer’s 70s or earlier. Although the income stream tends to be more significant than that of a SPIA, uncertainties surrounding the timing of when one may need that money exist.
In comparison to SPIAs and DIAs, indexed and variable annuities are often regarded as more complex and may entail higher fees. Advisors caution investors that insurance agents may have vested interests in selling these annuities due to their higher commissions. While indexed and variable annuities offer income riders that provide future income streams and liquidity, they can be challenging to comprehend. Furthermore, they carry strict rules about access, which incur financial penalties if violated.
The surge in annuity purchases in 2023 reflected consumers’ concerns about the stock market’s volatility and the overall economy. With higher interest rates prompting greater returns, annuities became an increasingly attractive investment choice. Although fixed-rate deferred annuities dominated sales, there remains a disconnect between the types of annuities recommended by financial advisors and those purchased by consumers. It is imperative for investors to understand the nuances and complexities associated with each annuity type before making informed decisions about their financial futures.