The growth in annuity issuance over the last couple decades has been enormous. In fact, there were $228.8 billion in total annuity sales in 2015 alone, according to the Insured Retirement Institute.1 Persistent low interest rates bring major challenges for investors, especially retirees trying to live off of fixed income. And the fear of outliving your money (perpetuated by the financial industry’s advertisements) has aided this growth. It is also no coincidence that the ability of Wall Street financial advisors to sell certain types of annuities, variable annuities predominantly. According to Morningstar, at the end of 2015, there were $1.87 trillion in variable annuity net assets.2 Here is some basic background on annuities.
What are Annuities?
An annuity is a contract between a buyer and an insurance company where the insurer agrees to pay regular, scheduled installments to the owner, in exchange for payment. The payments can be made in one lump sum or periodic installments. The reason for its use is it places the investment and longevity risk onto the insurance company.
What are the Different Types of Annuities?
There are a large number of different annuities subtle variations but they basically can all be classified as a few main types of annuities. Annuity payouts can either be immediate (technically within one year) or deferred (at some point in the future, typically upon entering retirement. Immediate payouts often occur after receiving a lump sum premium payment by the annuity buyer. In exchange, the annuitant receives guaranteed annuity payments, typically for the rest of their lives. Choosing this annuity helps solve a problem of people outliving their money. When the annuitant passes away, the immediate contract ends, so if the annuitant dies prematurely, the insurance company “makes out better” in a financial sense.
The annuity’s returns can either be fixed or variable. Fixed annuities are similar to a bank CD and pay a fixed rate of interest. Conversely, the variable annuities are equity-based and the returns are often tied to an underlying index or mutual funds. There are a number of different variations on these including indexed annuities and guaranteed income annuities.
Risks in Annuities
If an investor was able to accumulate large portion of money and get a decent rate of return from the bank or government bonds there wouldn’t be such a need for annuities. But these low rates have also added significant risk to insurance companies portfolios, something not often talked about. It is generally accepted that rising interest rates will be good for financial companies because they can increase their net interest margins and invest in higher yielding securities there is a risk that’s often overlooked. Since rates have been so low for so long, insurance companies have accumulated an enormous amount of bonds and asset backed securities which could get hammered in value as rates rise, especially if the rise is faster than expected. This could impair their ability to pay out all of their obligations, including making annuity payments.
Further, annuities are often considered ‘all or nothing’ products, meaning the buyer usually pays a large chuck of their net worth in exchange for guaranteed payments. For variable annuities, there is the subject to market risk if the underlying investments don’t perform. Now, some may be ‘guaranteed’ to have a minimum rate of return but all these extras increase one of the main complaints about annuities-their high fees.
Annuity fees vary depending on the type but here are the basic fees:
- Mortality and Expense (M&E)
- Administrative Fees
- Surrender Charges
- Investment Management Fees
- Rider Fees or Charges
There are also hidden costs buyers need to be aware of, like caps on performance of equity indexed annuities. In short, there may be more cost effective ways to meet your financial goals.
Can I Sell My Annuity?
Assuming your annuity is transferable you can absolutely sell annuity payments. Selling annuities from structured settlements is a little trickier, in that a judge (located in the same jurisdiction as the seller) needs to sign off on the sale. Many frustrated annuity owners ask themselves, ‘can i sell my annuity‘ and the answer is yes.
Retirement or investment annuities can be sold without a judge’s decision. The annuity payments are sold for a lump sum of cash. The amount received will be a discount to the total value of the annuity, but if the annuitant is in need of cash to meet a variety of expenses including purchasing a vehicle for work or staving off foreclosure, it provides a source of cash. Of course, selling an annuity is a decision that needs to be considered carefully but can unlock a lump sum of cash to meet a financial emergency or other financial need.