Stock market investors loathe rising interest rates, but they have upsides — bonds are generating returns again and financial instruments like fixed annuities, with their returns tied to bonds, are up massively.
How much? Lifetime fixed-income annuity payouts are up 29% to 30% from a year ago, depending on your gender. Meanwhile, the Dow Jones Industrial Average is down nearly 20% since the beginning of January.
How do annuities work? Annuities can be very complex and difficult to understand. But the basic premise is easy. You give a carrier a lump sum of money and they can either guarantee a rate of return or guarantee a lifetime payment. If you choose a lifetime payout, you're creating your own personal pension.
The carrier makes returns on your money and thus is able to pay your money back to you in monthly payments, plus interest, and in the case of a lifetime payment, an additional mortality credit for the rest of your life. But there are many annuity varieties.
Not surprisingly, annuities are getting a lot of attention now. Worried investors got spooked and started fleeing to safety last year, as the huge run-up in stock prices seemed unsustainable. And obviously that turned out to be true. Now, more investors are seeking to protect some money, and achieve some income, outside the risk of the equities market.
"A lot of people thought the (stock) market was at a high and took some of their money off the table last year," said Peter Longo, vice president and director of insured solutions consulting at Janney Montgomery Scott, headquartered in Philadelphia. "So annuities were popular when the stock market was roaring and they're popular now for when the market has been plummeting."
Fixed-Income Annuity, As A Personal Pension, Now Or Later?
What people call an immediate annuity often means an income annuity, a type of fixed annuity. That's the kind described above.
Right now, the payout rates (or yields) for these annuities range from roughly 6.5% to as high as 7.78% for a lifetime annuity with a premium of $100,000. Rates are gender dependent (see table). If interest rates go higher, which is likely, annuity payout rates will probably increase as well.
Lifetime Payout Yields For A Fixed Income Annuity
Average competitive payouts across carriers for a premium of $100,000 invested from February through August 2022.
| Date | Single male 70 | Single female 65 | Joint 70/65 |
|---|---|---|---|
| August 31, 2022 | 7.78% | 6.54% | 6.80% |
| July 27, 2022 | 7.83% | 6.59% | 6.14% |
| June 29, 2022 | 7.75% | 6.48% | 6.03% |
| May 25, 2022 | 7.70% | 6.44% | 5.98% |
| April 27, 2022 | 7.39% | 6.13% | 5.67% |
| March 30, 2022 | 7.11% | 5.87% | 5.42% |
| February 23, 2022 | 6.91% | 5.68% | 5.25% |
Source: Cannex Financial Exchanges
Another type of income annuity is a deferred fixed-income annuity. That's when a person pays the money into a carrier (either a lump sum or over time) and then the carrier invests it before starting payments after a period of time determined by the annuity holder (typically five to seven years). By doing this, the money can grow before payout begins and taxes on the gains are deferred.
Annuities payouts are taxed as income, not capital gains. But if the annuity is created with post-tax money only, the interest/growth portion of the payout is taxed.
Also, beware of smaller carriers. They might offer a higher payout or interest rates, but how safe is your money? Ask about a carrier's rating. Moody's, S&P Global Ratings, A.M. Best Co. and others rate annuity carriers.
Annuity investors are often retirees or those doing retirement planning who want to diversify their portfolio and lower their exposure to stocks. But they're also "trying to make up more income beyond Social Security," said Jeff Donham, a certified financial planner and senior wealth advisor with Colony Group. Fixed-income annuities "have the benefit of supplying a guaranteed income stream," he said.
Example Payouts Now Vs. A Year Ago
To make the improvement in the fixed-annuity picture clear, here are some examples using data from Cannex Financial Exchanges, based in Toronto, an exchange where financial advisors can see annuity rates from many annuity companies.
A woman age 65 buys a fixed-income annuity now with $100,000 for payment starting in October. If she chooses an annuity from Guardian Insurance and Annuity (a highly rated carrier), the lifetime monthly payout would be $553.31. Last year, the same annuity from Guardian would have paid $425.89. That's an increase of 30% and over 20 years that amounts to more than $30,580. And assuming the woman collected for 20 years, the total payout for her October 2022 immediate annuity would be $132,794.
If a man age 65, was to buy a fixed-income annuity right now with $100,000 for payment starting in October from Guardian monthly, payout for life would be $568.75 vs. $440.47 last September. That's a 29% increase, or over 20 years that's $30,787. Assuming the man collected for 20 years, the total payout for this year's immediate annuity would be $136,500. Collect for another five years and the total payout goes to $170,625.
Or how about this scenario: A man age 65 is doing some retirement planning and buys a fixed-income annuity today for $100,000 from Guardian, but defers his payout to start in five years. His monthly income goes up to $802. Over 20 years that's a payout of $192,480. And if he collected for another five years? That's $240,600.
These are nice returns. But of course they're less than more risky investments. More risk, more reward.
And annuities aren't totally without risk. If you die a few years after buying one, and you didn't set it up so the annuity goes to your spouse, the premium you put in could be gone. Or if you die earlier than you expected, the overall payout will obviously be substantially less.
Fixed Annuity As A Bond Or CD Alternative
Investors also can purchase a short-term deferred annuity, as short as three years, as a place to park cash and make a return. The industry uses yet another term for these: multiyear guaranteed annuities, or MYGAs.
With inflation rampant, your cash is losing purchasing power every day.
"A fixed rate annuity is similar to a bank CD, but you get a much better return than you do on a CD" or in a savings account, said Gary Baker, chief operating officer of Cannex.
In September of last year, three-year, fixed-rate annuities ($25,000 premium) were earning roughly 1.05% to 1.55%, but now they're earning 3.60% to 3.90%, according to Cannex. "A three-year annuity can be a cash alternative," said Longo. "It's a safe haven to get a fixed rate."
For comparison, according to the FDIC, the national average annual percentage yield on a three-year CD was 0.66% as of Sept. 19, 2022.
Variable And Indexed-Linked Annuities
Variable annuities and index-linked annuities may be tied to the returns of an investment portfolio or stock indexes and can offer more growth than those tied to interest-rate returns. They can be an alternative to mutual funds.
But they're riskier than fixed-income annuities, more complicated and can come with much higher fees. And to make matters even more complex, these annuities can be set up with a variety of options and riders for either continuing a systematic withdrawal payout to a spouse after the annuity holder dies, providing some form of principal protection, or using the money for long-term care costs.
Some annuities have rules that allow policyholders to withdraw some or all of the money, but again that's a feature that must be in the contract at the time the annuity is created.
In total, average fees on a variable annuity are 2.3% of the contract value and can be more than 3%. That's much higher than the fees on ETFs or mutual funds. Riders, those clauses that add features to an annuity, can run from 0.25% to 1% a year.
But some fixed and indexed annuities can be purchased without fees — the cost is covered by the spread between the interest rate the buyer gets versus the interest rate the annuity company can get.
When considering investing in an annuity, "talk to a professional financial adviser who isn't necessarily selling the product," then once you decide to buy an annuity you can "buy it through an insurance company," said Donham.
Follow Kathleen Doler on Twitter @kathleendoler.
