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Last year, amid stock market volatility, recession fears and higher payouts, consumers pumped a record amount into annuities, a type of insurance that offers a guaranteed income stream.
Limra, an insurance industry trading group, estimates that buyers will have invested $310.6 billion in annuities in 2022.
That figure is a 17% increase from the previous record set in 2008, when consumers bought $265 billion in annuities. That year, the US was in the midst of the Great Recession and the stock market eventually bottomed, losing 57%.
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It looked similar in 2022 S&P 500 Index posted its worst loss since 2008, ending the year down 19.4%. The US Federal Reserve aggressively hiked interest rates to curb stubbornly high inflation, stoking fears that the central bank could inadvertently plunge the country into recession.
“In ugly times, people worry about safety,” said Lee Baker, a board-certified financial planner and founder of Atlanta-based Apex Financial Services and a member of the CNBC Advisory Board.
‘Unique’ confluence of factors drove bond sales
There are many types of annuities. They generally fall into two categories: an investment or quasi-retirement plan that provides a guaranteed income for life in retirement.
All annuities are issued by insurance companies that cover risks such as market volatility or the risk of savings surviving in old age.
Annuities have also benefited from the Fed’s rate hike cycle, resulting in better returns on capital. Meanwhile, US bonds – which typically act as ballast when stocks fall – experienced their worst year on record in 2022, leaving few options for savers looking for relative safety and a decent yield.
“This has been a unique year,” said Todd Giesing, associate vice president of Limra Annuity Research, of the combined factors that led to record annuity sales.
Anything that is based on protection and offers some protection against disadvantage is doing very well.
death Giesing
Associate Vice President of Limra Annuity Research
Consumers have been particularly bullish on fixed-rate deferred annuities over the past year. Total sales — $112.1 billion — more than doubled from 2021, breaking the previous annual record in 2002 when consumers bought $80.8 billion, according to Limra data.
Fixed rate deferred annuities work like a certificate of deposit offered by a bank. Insurers guarantee a return over a set period of time, maybe three or five years. At the end of the term, buyers can get their money back, put it into another annuity, or convert their money into a source of income.
Another category — indexed annuities — made $79.4 billion, up 8% from 2019’s record, Limra said.
Indexed bonds hedge against downside risks. They are tied to a market index like the S&P 500; Insurers cap profits when the market is doing well, but put a floor on losses when there is a slump.
“Anything that’s protection-based and has some protection against downside is doing very well,” Giesing told CNBC last fall.
Meanwhile, consumers have shied away from variable annuities, the performance of which is generally directly linked to the stock market. Annual sales of $61.7 billion were the lowest since 1995, Limra said.
While the confluence of factors in 2022 — such as large stock and bond losses and rapidly rising interest rates — is unlikely to last in the short term, demographic trends such as baby boomer retirements underpin the long-term growth potential for bond sales, Giesing said. The average buyer is about 63 years old, he said.
This is how you can find out whether a pension makes sense for you
According to financial advisors, annuities may not make sense for everyone.
Advisors often recommend some less common annuity types when creating financial plans: a single premium immediate annuity or a deferred income annuity.
These are intended for retirees who want a guaranteed, pension-like income every month for life. Payouts from immediate annuities begin immediately, while those from deferred annuities begin later, perhaps in a retiree’s 70s or 80s.
These payments, along with other guaranteed sources of income like Social Security, help ensure a retiree has cash to cover necessities like a mortgage, utilities, and groceries if they live longer than expected and their investments are depleted or dwindling.
The fancier the annuity, the more the underlying fees accrue. And a lot of people don’t understand the limitations. It is important to know what you are buying.
Carolyn McClanahan
Founder of Life Planning Partners
“Am I worried that the customer will run out of money? If so, then I’m thinking about retirement,” Carolyn McClanahan, CFP and founder of Jacksonville, Fla.-based Life Planning Partners, told CNBC.
McClanahan, a member of CNBC’s Advisory Board, does not use lump sum annuities or deferred annuities for clients who have more than enough money to live comfortably in retirement.
Annuities are becoming more of a preference for those who fall somewhere in the middle: clients who will likely, but not necessarily, have enough money. For them, it’s more of an emotional calculus: will a higher guaranteed income offer peace of mind?
“Many people don’t understand the restrictions”
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Of course, different categories of annuities come with trade-offs.
One-time premium immediate annuities and deferred annuities are relatively easy to understand compared to other categories, the advisers said. The buyer transfers a lump sum to the insurer, who then guarantees him a certain monthly payment either immediately (immediate annuity) or later (annuity deferral).
They also offer retirees the best bang for their buck compared to other types, according to advisors and insurance experts.
That’s because they don’t come with bells and whistles that cost buyers money.
“The fancier the annuity, the higher the underlying fees,” McClanahan said. “And a lot of people don’t understand the restrictions. It is important to know what you are buying.”
For example, consumers can buy variable and indexed annuities with specific features — known as “guaranteed living” — that give buyers a choice between a lifetime income stream or for liquidity (i.e., some of their money back) if they need money early or don’t want their investment more. These features also generally come with higher costs, as well as restrictions and other fine print that consumers may find difficult to understand, advisers said.
In contrast, consumers cannot recoup their capital when they purchase single premium immediate annuities or deferred income annuities. That’s a likely reason consumers aren’t quick to buy them, despite their income efficiency, Giesing said.
Immediate pension against single contribution Revenue in 2022 was $9.1 billion and consumers bought about $2.1 billion in deferred income annuities, Limra said. For comparison, these figures account for about one-twelfth and one-fifty-third of fixed-rate deferred annuity sales, respectively.
Protection-focused annuities might make sense for someone five to 10 years away from retirement who can’t stomach the investment volatility and is willing to pay a slightly higher cost for stability, Baker said.
However, their value proposition may not make sense for all investors as they now offer a yield of over 4% on safe haven assets such as shorter dated US Treasuries (a 3 months, 1 year And 2 years, for example) if they hold those bonds to maturity, Baker said. However, these government bonds do not guarantee a specific income stream like annuities.
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