New Looks in Annuities

Recent changes are making annuities hot again. At least that’s what the annuity sellers want you to believe. Some of the new annuity features are attractive. But others are just sales gimmicks.

The biggest changes are in fixed annuities. The bear market in stocks initially drew investors to safer investments, such as fixed annuities. But low interest rates dimmed their luster, especially since the rates would be locked in for several years in many annuities. With the prospect that market interest rates would rise, the lock-in of lower rates became a deal breaker.

Now, many insurers offer annuities with shorter initial guarantee periods. Some are as short as six months, while many are one year. After the guarantee period, the yield will be adjusted. The appeal is that the buyer will not be locked into a low yield as market interest rates rise over the next year or two.

The feature, however, doesn’t mean you will benefit fully from rising rates. An equally important feature is the method the insurer uses to set yields after the guarantee period ends. Annuity buyers often are disappointed by the yields they are credited with after the guarantee expires. Ideally, the future rates should be determined by market interest rates. Learn the yield you would receive today if the formula were used. If the formula yield is less than the current guarantee, then you are likely to be disappointed with the future yields.

Also, be sure you know the costs that will be subtracted from the initial yield to arrive at the yield that actually will be credited to your account.

Instead of looking for a short guarantee period, consider an annuity in which the no-penalty surrender period is the same as the guaranteed yield period. That way your interests and the insurer’s are closer to being aligned. If the insurer wants to credit a low yield after the guarantee expires, you will be able to take the money elsewhere without penalty.

You can find a number of such annuities. They often are referred to as CD-type annuities. They function much like bank certificates of deposit, because the yield guarantee period can be as long as five years. The longer the period, the higher the yield is. The yields on the annuities tend to be a little bit higher than yields on comparable bank CDs.

Anytime you consider a deferred annuity, check the surrender penalties. A big chunk of your credited interest often is lost if you withdraw from the annuity before the end of the surrender period.

Variable annuities also are making a comeback. Many insurers responded to the bear market and fears of another bear market by touting the death and living benefits of variable annuities. Though the detailed terms differ, these benefits guarantee that the owner or the beneficiaries will receive at least the original investment regardless of what happens to the markets and the account’s investments. That can be very comforting.

Of course, these benefits come at a steep price. About 0.35% of the account’s value each year is the typical charge for the protection. What value do you receive for this fee? A variable annuity should be a long-term investment, as I’ve recommended in past visits. The major stock indexes have never lost value over any period of 15 years or longer. If you bought the variable annuity for the long term, then the benefits provide no value beyond what the markets are very likely to produce. Also, read the policy carefully. The benefits can contain some surprising limitations.

In addition, the protection is based on the account’s value. As the value rises, the cost of the protection is higher. Yet, the protection is less valuable and less likely to be needed as the account’s value rises. Also, you cannot cancel the coverage if the account value increases enough that you no longer are concerned that a bear market might wipe out all the gains and part of the principal. You keep paying for a benefit that no longer provides value.

If you are insurable, it probably is cheaper and more efficient to buy a 10- or 15-year term insurance policy equal to the annuity’s principal. That policy always can be dropped if you decide it no longer is necessary.

Annuities can be an important part of a retirement portfolio. To get the most benefit from an annuity, keep up with changes in the markets and select the features that work best in your situation.