By Katie Benson
Beginning in 2022, the United States witnessed a significant uptick in the sales of annuities. Annuities became a desirable asset due to heightened volatility in the equities markets and increasing interest rates. LIMRA (The Life Insurance Marketing and Research Association) says that total U.S. annuity sales in 2022 soared to over $310.6 billion. This uptick is a 23% increase over 2021, surpassing the previous sales record set in 2008 by 15%. Such a dramatic surge in annuity purchases can be attributed to investors’ growing concern about safeguarding their retirement income. Annuities provide something of a buffer against several economic challenges, including inflation, rising energy costs, and fluctuating interest rates.
Do you need an annuity in 2023?
The looming demographic shift, with an estimated 80 million Americans aged 65 and older by 2040, has spurred some of the current interest in annuities. With multiple challenges on the horizon, people are looking for anything that can help ensure the stability of their retirement income streams.
Fueling the demand for safe money products such as annuities are factors such as:
- Rising inflation: The Consumer Price Index reported a 40-year high in inflation, reaching 9.1% in June 2022, eroding the purchasing power of retirees. In 2023, runaway inflation continues unabated, with Federal Reserve policies doing nothing to stop it.
- Energy costs: Energy costs began piking in 2022 due to geopolitical tensions, such as Russia’s invasion of Ukraine and other military actions around the globe. Higher prices for nearly everything were an immediate consequence of this global energy instability.
- Rising Interest Rates: Since the Federal Reserve raised the Federal Funds Rate from 0.25% to 5.25% starting in March 2022, bond valuations have decreased. Over the past year and a half, the Federal Open Market Committee (FOMC) has increased interest rates 11 times, bringing its federal funds rate to a target range of 5.25-5.5 percent.
How can an annuity help?
As you probably know, annuities come in various forms. Each of these contracts offers distinct benefits and drawbacks. The kind of annuity you decide to buy (if any) depends on your money goals, risk tolerance, and other financial circumstances. You can select either fixed or variable products.
Multi-Year Guaranteed Annuities (MYGAs) are a popular option in 2023.
A multi-year guaranteed annuity, or MYGA, is a type of fixed deferred annuity created to shield investors from market volatility, offer tax-deferred growth, and provide a guaranteed income stream during retirement. MYGAs offer locked-in, guaranteed rates of return for a specified term, typically ranging from three to nine years.
How does a MYGA work?
When you buy a MYGA, you enter into a contract with an insurance company. You select a single premium amount based on your financial goals, with minimum and maximum premium limits that vary among annuity companies. The insurer guarantees a fixed interest rate on your premium for the chosen period. Interest is credited regularly, and at the term’s end, you can renew, leave the funds at a fixed account rate, elect a settlement option, or make withdrawals.
MYGAs offer several advantages:
- Guaranteed Rate of Return: MYGAs provide you with a more predictable return because they have a fixed interest rate guaranteed for the contract’s term.
- Protection from Market Volatility: MYGAs are not correlated to the market and are essentially immune to market fluctuations.
- Tax-Deferred Growth: Taxes on MYGAs are deferred until you start taking withdrawals. This benefit allows your earnings to compound and grow tax-free.
- Access to Guaranteed Income: MYGAs may provide a steady source of income you’ll have for life.
- Leaving a Legacy: A MYGA lets you leave any money remaining in your account to your beneficiaries, creating an instant legacy.
Risks of MYGAs
Despite their benefits, MYGAs, like all financial products, come with certain risks:
- Limited Liquidity: Early withdrawals may incur penalties.
- Potentially Lower Returns: MYGAs nearly always yield lower returns compared to riskier investments.
- Fees and Expenses: Some MYGA issuers include surrender charges, administrative costs, and potential market value adjustments (MVAs) that can reduce returns.
- Inflation Risk: A MYGA’s fixed returns may not keep pace with inflation.
- Lack of FDIC Insurance: MYGAs are not federally insured; their guarantees depend on the issuing company’s financial stability and claims-paying ability
MYGA Withdrawals
Many MYGAs allow penalty-free withdrawals before the contract expires. The relevant terms of these early withdrawals depend on the specific contract. Often, your withdrawals are capped at a particular percentage of the accumulated value each year, and you won’t have surrender charges. Market Value Adjustment (MVA) and Return of Premium (ROP) are standard features affecting withdrawals.
- Market Value Adjustment (MVA): MVAs allow the company to adjust the surrender value based on changes in interest rates, protecting the company.
- Return of Premium (ROP): ROP provides for a return of premium payments under certain conditions, enhancing your access to funds.
What happens at the end of a MYGA’s term?
At the end of your MYGA’s term, you have several choices. You can:
- Renew for another term by selecting a new guaranteed period.
- Automatically transition to a fixed account: This option lets you move the accumulated value into a fixed account.
- Elect a settlement option: When you exercise this option, you will choose either a guaranteed income stream for life or a contractually specified time.
- Surrender your MYGA and take the value. Taking the value means you will withdraw your accumulated value without incurring surrender charges.
How is a MYGA different than a CD?
Both MYGAs and certificates of deposit offer guaranteed returns. However, there are distinct differences:
- MYGAs typically offer higher interest rates than CDs.
- MYGAs provide tax-deferred growth, while CDs are taxed annually.
- MYGAs are issued by insurance companies. Banks or credit unions provide CDs.
- Both MYGAs and CDs may impose early withdrawal penalties. A MYGA’s penalties may impact both interest and principal, though.
Who Should Consider MYGAs?
MYGAs tend to appeal to more conservative investors, especially those nearing or in retirement. They are suitable for individuals looking to:
- Secure a guaranteed interest rate.
- Shield themselves from market losses.
- Benefit from tax-deferred earnings growth.
- Ensure a guaranteed stream of income.
- Leave a financial legacy.
Before deciding on any financial tool, it’s essential to review the product and research the issuing companies thoroughly. You’ll want to know both the benefits and possible pitfalls. It’s a good idea to speak to a financial advisor who specializes in safe money products. That way, you’ll be sure that your decision aligns well with your unique financial goals and needs. If you’d like a second opinion, reach out to me and I will gladly assist you.
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