Why Fixed Annuity Sales are Soaring

Fixed annuities are drawing many more investors these days, especially annuities sold through banks. Insurance companies report sales are 80% and more above last year’s sales.

Several factors make fixed annuities more attractive relative to other investments than in the recent past:

• Volatility and steep losses in stocks and many types of bonds make them less appealing to conservative and moderate investors.
• The financial crises caused a flight-to-safety that brought down yields on safe and short-term investments. Yields on money market funds, certificates of deposit, and short-term bond funds are very low, causing investors to seek higher yields.
• The yield curve is steep, meaning long-term rates are higher than short-term rates. Investors are paid more for locking their money up for longer periods, as in annuities.
• Changes in annuity products make them attractive to more investors.

Banks are finding that many customers with maturing certificates of deposit are opting to put the money into fixed annuities instead of rolling it over to new CDs. If you are inclined to consider a fixed deferred annuity for your safe money, be sure an annuity is appropriate for you and that you shop for the best deal.

Fixed deferred annuities are tax-advantaged vehicles, because earnings on the account compound tax deferred as long as they stay in the annuity. Earnings are taxed as ordinary income when withdrawn.

The yield on the account usually is determined by the insurer based on what it expects to earn on its portfolio. Generally the yield is similar to that of intermediate term bonds. Most fixed annuities adjust the yield annually, and many now guarantee a modest minimum yield of 1% to 3%. But some guarantees are much higher. New York Life, for example, has an annuity guaranteeing a 6% yield for six years.

To some extent annuities are much simpler than they used to be. Insurers used to offer teaser interest rates, interest rate bonuses, and other features that were supposed to attract investors. But these features confused investors and made them uncertain of the yield they would earn. Most of the confusing features have been dropped.

Fixed annuities offer higher yields than CDs partly because annuities are less flexible. Money is locked up for a longer term. This lockup stifled annuity sales in the past, so insurers added more flexibility. Many fixed annuities now allow the owner to withdraw up to 15% of the account each year without incurring a penalty.

Banks also are training their employees to recognize potential annuity customers. Investors need to examine some key issues when considering an annuity.

• Don’t stop your review at the stated first year yield. Most annuities change the interest rate at least annually. You need to know how often the rate will change and how the new rate is determined. Many insurers say the yield will be determined by their investment experience. If so, you’ll want to see the yields the insurer has credited to accounts for at least the last 10 years. Compare those yields with intermediate bond yields. While the history is no guarantee that you’ll get competitive yields in the future, it does indicate the insurer’s investment record and style. Other insurers determine the yield by reference to market interest rates. Be sure the formula would give you a yield close to that for intermediate bonds, not money market fund or CD yields.
• Don’t focus on a stated or advertised yield. The net yield is the one that will be credited to the account. Insurers deduct various fees and expenses from the gross yield before arriving at the net yield. Be sure you see the difference between the “gross yield” that is the starting point and the “net yield” that actually will be credited. Sometimes it is tough to find the details, but you need to know what will be deducted from the gross yield.
• Don’t be fooled by high teaser first year yields and other gimmicks. As we said, these are being phased out but some insurers still promise an initial above-market yield that is guaranteed for only six months or one year. After that, the insurer is likely to credit the account with below-market yields. Don’t be overly impressed by the yield you’ll receive now. Pay more attention to how long that yield will last and to how future yields will be determined.
• Learn how long the money will be locked up and any penalties that will be charged for early withdrawal. The standard penalty is 7% of the account value for withdrawals within one year. The penalty drops by one percentage point each year until it disappears after seven years. Other annuities might recalculate the interest rate for the time you owned the annuity so that only a money market rate or something similar is earned.On most fixed annuities now you should be allowed to withdraw 10% to 15% of the principal in any year without a penalty. You should look for alternatives to any annuity that imposes high penalties or restrictions.
• Check for payout restrictions. Some annuities offer attractive terms during the accumulation phase then take the advantage away during the distribution phase. The insurer might require “annuitization” at maturity, meaning you must take fixed, periodic payments over your life expectancy. Some annuities can be exchanged only for another annuity from the same insurer. Of course, you want maximum flexibility. You want to be able to annuitize, set a payment schedule over a period of years, withdraw the account as a lump sum, transfer the annuity to another insurer, or take periodic withdrawals without a schedule.
• Examine the financial stability of the insurer. Earning a high yield doesn’t do much good if the insurer goes bankrupt. Annuities are not federally insured. Most states have a modest insurance guarantee fund, but they don’t amount to much. Your only real guarantee for the annuity is the financial stability of the insurer.Insurers with the lower safety ratings generally offer higher yields. Few insurers go bankrupt and many perk along profitably despite relatively low safety ratings. Decide if a lower safety rating is a risk you want to take. Examine ratings from all four rating agencies. The Weiss ratings tend to give lower scores than the others. Stick with insurers in the top groups of ratings from at least a couple of the raters. Any insurance broker or web site selling annuities should have the ratings.
• If an annuity is for you, be sure to shop around. My studies over the years consistently show that annuity yields vary considerably, even among top-rated insurers. The internet makes annuity comparisons easier. Check sites such as ImmediateAnnuities.com and WebAnnuities.com.

In addition to fixed annuities, savers are interested in equity indexed annuities. These annuities have different names. Their common feature is that their yields are determined by a formula that makes reference to the performance of a stock index. We covered these in detail in past visits, most recently in the June 2008 issue. The articles are in the Annuity Watch section of the Archive on the members’ section of the web site.

Annuity marketers are benefiting from stock market volatility and poor returns. Banks especially seem to have ramped up their annuity marketing. Fixed deferred annuities have their place in some portfolios. But not all annuities are the same or appropriate for you. Check their features and shop around. Buy only an annuity that maximizes your wealth with the right trade offs.