Broker Check

Monday Money Report

| September 21, 2020

The market declined about 1% last week.  While unemployment claims continue to decline, the Federal Reserve Bank reaffirmed they will keep interest rates low until inflation increases, and probably for the next few years at least. We also saw the impact of quadruple witching, when options and futures on stocks and indexes are set to expire, causing market swings.  And finally, rising trade tensions with China have added to the uncertainty.

On the flip side of that, we’ve gotten some questions lately about annuities, which are all about certainty.  There are more varieties of annuities than we have time to discuss.  It’s kind of like the list of shrimp recipes Bubba gives Forrest Gump.  With that in mind, there are some basics you should know.

An annuity in an insurance product, and the best explanation is in comparison to life insurance.  Life insurance creates an estate: you pass away, and there is a lump sum of money for your heirs.  Life insurance also protects against dying to soon.  An annuity is the opposite.  It liquidates an estate, in that you give the insurance company a lump sum of money, and they give you regular payments over a set period of time, often for life. Annuities also protect you from living too long, in a financial sense.

You can put annuities into one of four boxes: if you draw a grid, one side would have fixed vs variable, and the other would have immediate vs deferred. If we break down each of those options, a fixed annuity is one that is not invested in the market.  The insurance company pays a set interest rate, which is credited to your account balance. A variable annuity is one that is invested in securities.  Technically, we call the investments held in annuities “separate accounts”.  They work much like mutual funds but they are only available through an insurance product.  We call them separate accounts because they are separate from the insurance carrier’s general fund.

There’s a type of fixed annuity that seems to straddle the line between them, although it is a fixed product.  Indexed annuities are fixed annuities, but the interest that the insurance company pays you is based on the performance of one or more stock market indices. 

On the other side of the box, immediate annuities are those that begin paying out an income stream immediately. Deferred annuities allow you to invest your money and turn on income later, or even never. 

Annuities are also tax-advantaged.  Any growth inside the annuity is not taxed until you take it out from the annuity. When you do take it out, how it is taxed depends on the distribution method.  If you annuitize the contract, meaning you are just going to be taking a regular income stream, each payment is a combination of a return of principal – you are getting your own money back, which is not taxed – and gains – increases in the account value, which is taxed as ordinary income. If you just take money out, whether than is a regular distribution or an occasional lump sum, the gains come out first, and are fully taxed as ordinary income.  And if you take a lump sum out prior to 59 ½, there is a 10% penalty for early withdrawal.

Another basic annuity fact you should know is the surrender period.  When an insurance carrier issues an annuity, there is a minimum time period they expect to keep your money.  This time period is called a surrender period.  If you cash out the annuity during that time, there is a penalty, or surrender charge.  Similar to a CD, where the interest rate increases with the length of the CD, fixed annuities usually pay higher rates with longer terms.

While the industry has begun to introduce advisory annuities, or products where the client pays a fee to the advisor for managing their money, most annuities are sold on a commission basis, where the annuity company pays the advisor.  With a commissioned product, there is usually an upfront commission, which can be as much as 7%, and then annual payments known as trails.  Usually, the bigger the upfront commission, the lower the annual trails.

Why would someone purchase an annuity? Most of the time, an annuity is purchased for the guaranteed income stream.  That guarantee is backed by the claims-paying ability of the insurance carrier.  Sometimes the industry will refer to this as a private pension – you are giving part of your assets to an insurance company to create a monthly payment.  We also use fixed annuities as a cash replacement, meaning it’s a reasonably safe place to hold money with a guaranteed interest rate.  Finally, you might consider an annuity for tax deferral.  Investment-only variable annuities, or annuities without any of the bells and whistles, can allow you to invest in the market while deferring taxes on the gains until you take the money out.

Feel free to reach out to us with questions on annuities, or to discuss why – or why not – to purchase one.  As independent financial planners, we have a variety of resources and no proprietary products. 

We also have some great educational events over the next two months, including virtual talks on Healthcare in Retirement, Social Security, and our Retire on Purpose and Women, Wine and Wisdom seminars.  You can register for these and more on our website,, or check out our Facebook page to learn more.  

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. CovingtonAlsina and Great Valley Advisor Group are separate entities from LPL Financial.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investment(s) may be appropriate for you, consult with your attorney, accountant, and financial advisor or tax advisor prior to investing.