Average allocations to annuities rose last year, in part, as a response to the market meltdown of late 2008 and early 2009, as investors sought safer income-like investments. According to a 2010 survey conducted by Cogent Research, annuities accounted for 9.65 percent of portfolio assets on average in 2009, up from 6 percent of assets in 2006. The nationwide survey was based on the responses of 4,000 affluent investors with average assets of $740,000, excluding real estate. Allocations to annuities were up across all age and wealth segments--particularly among cautious affluent investors, the Cogent study showed.
Despite the rising ownership of annuities over the past three years, sales of annuities largely declined in 2009. But equity index annuities, which sported an average return of 5 percent in 2009, and fixed deferred annuities, which paid, on average, rates of 4 percent, were the exceptions.
Equity index annuities, which typically pay a variable rate, based on index performance, saw sales hit $29 billion in 2009, a 9 percent increase versus 2008. Equity index annuities often contain an interest rate floor, say 2 percent to 3 percent, which attracts safety-minded investors. Of course, there is a cap on gains as well: investors may only earn 60 percent of the upside performance of an index. The annuity return also excludes the reinvestment of dividends. And like other annuity products, this type of annuity comes with back-end surrender charges.
In 2008, equity index annuities tied to the S&P 500 continued to pay interest and gained over 5 percent, outshining the actual S&P 500 index, which lost 38 percent. Jack Marrion, president of Advantage Compendium, a St. Louis-based research company, says investors view equity index annuities as an alternative way to invest in the stock market. “I advise against viewing them as safe, high-return investments,” he says. “Rather, you should view them as an alternative to investing in stocks.”
Meanwhile, fixed deferred annuity sales totaled $95.2 billion in 2009, up just a hair from $95 billion in 2008, according to LIMRA. Industry sources cited low interest rates as the reason behind the flat sales.
“The public demand for fixed rate investments has been extremely strong, as evidenced by the big boom in bond-related mutual fund sales,” says Judith Alexander, spokesperson for Beacon Research. “This drove down rates. Insurance companies invest mainly in corporate bonds to back the fixed annuities they issue. So not only were they able to pay annuity buyers less interest, but fixed annuities had less of a rate advantage over bank Certificates of Deposit and other conservative interest-bearing investments.”
Overall sales of all types of annuities combined declined 11 percent in 2009, according to LIMRA. LIMRA cited low interest rates on fixed immediate and deferred annuities as well as economic and stock market concerns. Sales of tax-deferred variable annuities dropped even more, declining 18 percent in 2009 to $127 billion. Meanwhile, sales of immediate annuities dropped 10 percent to $7 billion in 2009.
And yet sales of immediate annuities have more than doubled since the beginning of the decade, as baby boomers have sought steady income streams for retirement. “One of the prime strategies today is to put a portion of assets in a fixed immediate annuity,” says LIMRA analyst Dan Beatrice. “This enables retirees to invest their remaining assets more freely.”
In considering annuities for their clients, advisors need to beware that:
· With immediate annuities, clients may be surrendering their assets to insurance companies. Although contract provisions can be made for beneficiaries to continue to receive income for a specific period, expect your client to receive a lower payout under this arrangement.
· Tax-deferred annuities and equity index annuities have back-end surrender charges that can last as long as 7 to 10 years. These penalties can prevent clients from taking advantage of better opportunities later on.
· Variable annuities can have as much as 300 basis points in annual charges due to investment charges, insurance charges and fund management expenses.
· Tax-deferred and immediate annuities ultimately have taxes on earnings. Withdrawals from variable tax-deferred annuities are subject to ordinary income taxes, which can run as high as 35 percent. Only about 50 percent of the income from immediate annuities is taxed. The rest is considered return of principle.