Annuities are contracts initiated between an investor and an insurance company that are designed to provide a steady stream of income beginning immediately or at a designated future date. According to Financial Planning Magazine, due to the unsteadiness of the financial market and global economy, investments in fixed annuities surged during the recession. It is important to know that some annuities can actually be more risky in this economy. Understanding the benefits and pitfalls of each annuity can help you diversify and traverse the recession more safely.
According to the Securities and Exchange Commission, annuities were created by insurance companies to provide periodic payments toward a long-term goal, such as retirement. Investors can deliver a lump-sum payment toward an annuity or they can pay the insurer over a period of time. Annuities are an appealing option for investor diversification because of their tax-deferred growth on earnings and possible death benefit for beneficiaries. Investors can receive payment over time or as a lump-sum. If money is withdrawn, investors will be taxed at normal interest rates as opposed to capital gains rates. Early withdrawal can result in surrender charges and tax penalties.
Fixed annuities allow for a guaranteed rate of interest to be paid while the account is growing, according to the Securities and Exchange Commission. Periodic payments can be paid over a designated time, such as 10 years, or over the course of a lifetime. Fixed annuities are not securities and are thus unregulated by the SEC. In 2008 during the early stages of the recession, fixed annuity sales soared at a record pace, according to Financial Planning Magazine. According to CNN Money, the predictability of fixed annuities is often desired by those who need a steady steam of reliable income that can be used during a recession or during retirement.
Performance Valued Annuities
The interest rate received for a variable annuity is dependent on the performance of an investment tool. At the start of the recession in 2008, variable annuity sales slumped due to the uncertainty surrounding the stock market, according to Financial Planning. Indexed annuities are also dependent on investment performance; however, these annuities are linked only to index funds. Indexed annuities guarantee a contract value regardless of index performance. All variable annuities are securities, but some indexed annuities are not securities and remain unregulated by the SEC.
When in a slump, many investors prefer stability over greater yield. As a result, fixed and variable annuity performance have an inverse relationship in a bad economy. Although the risk of bankruptcy for both banks and insurers increases during a recession, state guaranty associations can provide protection for investors if insurers become insolvent. Unlike banks, insurance companies are conservatively managed, have stringent requirements, and rarely file for bankruptcy, according to CBS News. According to Market Watch, if an insurer is caught not disclosing the additional risk associated with variable annuities during a recession, its shares will drop, as it did for Manulife in 2009. The Annuity Disclosure Model Regulation provide specific guidelines for disclosure regarding the investment risks associated with variable annuities. The SEC also regulates variable annuities to protect investors.
- Securities and Exchange Commission: Annuities
- Financial Planning: Fixed Annuity Sales Surge as Variable Sales Slump
- CNN Money: Ultimate Guide to Retirement: Fixed Annuities
- CBS News: Are Annuities a Good Idea or Not
- Market Watch: Regulator Warns Manulife on Variable Annuity Disclosure
- National Association of Insurance Commissioners: Annuity Disclosure Model Regulation
- Hemera Technologies/AbleStock.com/Getty Images
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