Annuities are enjoying a renaissance lately, with sales jumping 10% in the second quarter. The trouble for consumers, though, is how to tell which of the plethora of annuity types is best for them. A variable annuity? A fixed indexed annuity? Huh?
Fortunately, there's new research on the subject from CANNEX Financial Exchanges, a consulting firm. It figures out the right type of annuities to buy depending on when the income is taken, income delay, gender and number of beneficiaries -- a single person or a couple.
The insurers that sell these retirement products, which essentially are insurance contracts, figure out the structure of the different varieties of annuity based on a bewildering host of actuarial, economic and other factors. Due to the ever-changing environment of annuity underwriting, Tomiko Toland, head of annuity research for CANNEX, cautions that the study's conclusions may shift in the future.
The appeal of annuities stems from a promise, after you plug money into one, to return a series of payments, typically for the rest of your life. It also helps that interest rates are rising, which should boost annuity payouts.
These vehicles have drawn fire for the high fees that some of them charge, reaching as much as 2% yearly. Part of the reason for annuities' sales resurgence lately may be the recent federal court action overturning the fiduciary rule, which required financial professionals to put customers' interests ahead of their own. This rule had crimped revenue because it required sales reps to favor lower-priced products. Now the reps have freer rein.
Annuities are divided into two basic types: Income annuities, where payouts start either right away or at later date, and savings annuities, namely those that allow time for an account's value to increase, offering the prospect of extra growth.
Generally with annuities other than an immediate payout contract, you must wait a while before you tap it, which in annuity-speak is the "accrual period," when its account value is meant to be growing.
Savings annuities often come with the option of a guarantee, a floor income level intended to ease the minds of those hoping for account growth -- and fearful of market reverses. One variant is something called a guaranteed lifetime withdrawal benefit, or GLWB, which allows you to withdraw money during the accrual period.
We describe the attributes of each variety of annuity, then give CANNEX's view on them:
Single-premium immediate annuity (SPIA). You give the insurer a lump sum in exchange for regular income payments until you die, or for a specified period, starting within 12 months after you hand over your principal. Because some people die earlier than expected, their unused money helps increase payments.
Deferred-income annuity (DIA). Payments are delayed until some future point, giving you more income than you would get with a single premium immediate annuity. This is useful if, say, you want to work well into your 70s and like the certitude of a replacement income stream afterward.
Variable annuity (VA). Investors choose from a menu of mutual funds, whose performance determines account value, which means it can fluctuate. The hope is that the funds will increase at a robust pace. This is the lone type of annuity with underlying assets from outside the insurance company. Most often, financing for annuity payouts comes from the vast pool of assets the insurer holds.
Fixed-rate annuity (FRA). This kind gives you gains at a fixed rate without the risk of equities, and thus no stock market fluctuations. You get the comfort of a specified interest rate, higher than bank certificates of deposit.
Fixed indexed annuity (FIA). It offers returns that are similar to a fixed-rate annuity but may be higher (or lower). The gains are linked to the performance of an index, like the S&P 500, so they are more risky. Sometimes an FIA has limits on market upsides. Example: If the S&P 500 rises 10%, only 7.7% might be credited to your account.
As a rule, men fare better in benefit payments than women, owing to women's greater longevity: Females get less over time since statistically they have more years on this earth.
There are other wrinkles. Usually, the lower the guarantee you pick, the higher your return. That makes sense: You're taking a higher risk with less of a safety feature. What's more, a savings annuity doesn't charge differently between the sexes, so with that type a woman is more inclined to get a higher income from a guarantee than is a man, who tends to be around less longer to enjoy the benefits.
Meanwhile, the longer you wait to receive benefits, with a savings annuity, the better off you are. If you want to start getting benefits in five to 10 years, the fixed indexed annuity has a better income stream than the deferred or variable annuity.
An illustration of how these differences might play out: A 65-year-old woman with an average longevity projection makes $100,000 in premium payments in a DIA. She receives, after a 10-year deferral, $11,700 in annual income, as opposed to $12,900 for a man. An FIA, though, generates $14,313 in income regardless of gender.
Annuity guarantees -- the income floors under the contracts -- differ depending on the type of product. For single annuity customers choosing a delay, a fixed indexed annuity with a guaranteed lifetime withdrawal guarantee provides the highest income floor. But for couples, a variable annuity delivers the biggest guarantee.
Yes, the world of annuities can be maddeningly complex. They may be worth the effort to explore, however.
About the author: Larry Light is the markets editor of Chief Investment Officer magazine. He has previously been an editor and reporter at the Wall Street Journal, Forbes, BusinessWeek, MONEY and CBS MoneyWatch. He is the author of Taming the Beast (John Wiley), a history of investment strategies.