Annuities and Market Risk: What You Need to Know

Annuities and Market Risk: What You Need to Know

June 21, 2021

Market risk is something all investors may worry about, but those close to retirement have limited time to recover from market loss. If you are within ten years of retirement, now is a critical time for your portfolio to continue to gain value and avoid loss.

Without thinking through the dynamics of gains and losses, investors leave themselves open to market risk  that could prematurely deplete their retirement assets.

One way that investors can mitigate risk is by including annuities in their retirement portfolio. Annuities, which are becoming more widely used in the financial services industry, are a contract with an insurance company to provide investors with a guaranteed stream of income in retirement. Annuities offer tax-deferred growth of earnings.

However, many investors still do not fully understand the different types of annuities, how they work, or the fees associated with them. Here is what you need to know about annuities and market risk:

The three types of annuities widely used in financial planning are fixed annuities, fixed-indexed annuities, and variable annuities. Like any financial product, there are pros and cons to each type of annuity, and due diligence should take precedence before purchasing one for your retirement portfolio:

Fixed Annuity Pros:

  • Provide a fixed rate of return the insurance company generates from investing in high-quality corporate and government bonds.
  • Grow on a tax-deferred basis.
  • The interest rate is typically guaranteed the first ten years of the contract, and a guaranteed minimum interest rate sets after the initial guarantee period to protect against declining interest rates.
  • Provides a guaranteed lifetime income and protection against longevity risk; annuity payments continue the rest of your life.

The Cons:

  • When the guaranteed rate expires, the rate is adjusted based on the earnings in the insurer’s investment account. If this occurs during a low- interest rate or unfavorable stock market environment, a lower rate of return may apply.
  • Can have high surrender rates from one to fifteen years and withdraws over ten percent during the surrender period incur fees.

Fixed-Indexed Annuity Pros:

  • Your principal is protected during a down market, and you won’t lose your initial investment or accumulation.
  • Accumulates on a tax-deferred basis.
  • The return is based on an index (ex. The S&P 500), which increases the annuity’s value over time.
  • Provides a guaranteed lifetime income and protection against longevity risk; you receive annuity payments for life.

The Cons:

  • Some are complex, costly, and aren’t always necessary for the investor.
  • Is not a growth-market product. Ask for written information from the insurer about the annuity product and don’t just accept a verbal explanation so you fully understand the product.

Variable Annuity Pros:

  • Grows on a tax-deferred basis like fixed and fixed-indexed annuities.
  • Includes pre-selected mutual fund subaccounts for the initial investment.
  • Offers unlimited contributions (some restrictions apply from the insurer).
  • Includes both living and death benefits through contract ‘riders.’ Beneficiaries can choose between the current contract values, its highest value on the contract anniversary, or determine a value based on a guaranteed hypothetical rate of return.

The Cons:

  • May come with many fees and charges, which decreases the accumulation.
  • Are market sensitive and may incur a loss to the investor.
  • May be considered a complex product by some investors.

Annuities offer benefits to investors and have their place in retirement planning, but only if suitable for their situation and as part of an investment strategy. Investors should fully understand the risks associated with annuities before purchasing them. If you have any questions about annuities, now is a great time to visit with your financial professional.


Important Disclosures:

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.

Fixed Indexed Annuities (FIA) are not suitable for all investors. FIAs permit investors to participate in only a stated percentage of an increase in an index (participation rate) and may impose a maximum annual account value percentage increase. FIAs typically do not allow for participation in dividends accumulated on the securities represented by the index. Annuities are long-term, tax-deferred investment vehicles designed for retirement purposes. Withdrawals prior to 59 ½ may result in an IRS penalty, and surrender charges may apply. Guarantees are based on the claims-paying ability of the issuing insurance company.?

Variable Annuities are suitable for long-term investing, such as retirement investing.   Withdrawals prior to age 59 ½ may be subject to tax penalties and surrender charges may apply.   Variable annuities are subject to market risk and may lose value.

All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.