8 Tips for Playing the Stock Market With Your Annuity

Let’s be honest. The future is looking more and more uncertain. And, that can definitely impact your finances—especially if you have money tied up in the stock market.

If there is a silver lining, if you’re an annuity owner, you probably can rest a little easier. For example, if the stock market crashes, and you own a fixed or indexed annuity, your money is safe.

That may not be the case with variable annuities though. The reason? This type of annuity is tied to a registered index. So, it’s possible that you could lose some, if not all, of you money.

I know. All this annuity talk can get complicated. But, maybe through the power of music, you can wrap your head around playing the stock market with your annuity.

Fear Is a Liar

Annuity salespersons sometimes rely on fear of the stock market to convince buyers to purchase the products that they’re offering. Are market fluctuations frustrating? Absolutely. However, corrections in the market are common in the investment cycle.

You don’t have to succumb to fear if you want to fund several years of cash flow needs without having to dip into your retirement portfolio. The catch? You have a properly constructed investment portfolio this offers adequate cash and other low-risk, low-volatility investments.

When working with retirees, it’s crucial that financial advisors develop a plan that maximizes the cash flow needs of their clients from available retirement assets. These include tax-deferred retirement accounts, pensions, and Social Security benefits. And, yes, this also includes annuities as long as they are suitable for the individual.

I’m Different

Often times you’ll find that annuities and stocks are pitted against each other. In other words, you have to pick one over the other.

Here’s the thing though. They’re two different types of investments options.

“Annuities are insurance products with contracts issued by life insurance companies, period,” explains Stan Haithcock. “Stocks are what they are.”

“In most cases, you buy them for growth,” he adds. “You buy them because you like the company, you think you’re going to get value out of the company.” Neither is superior to the other. It’s a matter of preference.

But, what exactly are the differences between the two?

“Annuities don’t solve for market growth,” says Stan. “Now, I warn you that you’re going to be pitched annuity types like variable annuities and index annuities like they will get market growth.” Well, that’s not exactly true.

There is however an argument for variable annuities since there are mutual funds within annuity policies. “But the reason I say don’t buy an annuity for growth is that even variable annuities have limited choices,” he continues. “And when you’re talking about stock market growth, I do not think you need limitations on the upside.

Robot Rock

Investing used to be a distinctly human activity fifty years ago. “People would have to take each other out, and dealers would entertain fund managers, and no one would know what the prices were,” Ray Dalio, who worked on the trading floor of the New York Stock Exchange (NYSE) in the early 1970s and founder of Bridgewater Associates, told The Economist. In those days, technology was elementary and limited to reading the Wall Street Journal or ticker tape.

Since then, humans have played a decreasing role in trading. “In their place have come computers, algorithms and passive managers—institutions which offer an index fund that holds a basket of shares to match the return of the stock market, or sectors of it, rather than trying to beat it,” notes The Economist article.

In other words, most people are unaware that non-humans perform most of the stock market trades. “Black box, high velocity, algorithmic, and institutional computerized trading systems dominate daily volume,” clarifies Stan in an article for The Street.

“I tell my clients that investing in the stock market and competing with the ‘big boys’ is like surfing beside a cruise ship,” he adds. “You might catch a wave now and then, but you will eventually get sucked under the boat.”

At the same time, this technology can be used to your advantage.

“Robo-advisors provide automated, algorithm-driven financial planning services with very little human intervention,” says Due founder and CEO John Rampton. “Most robo-advisors provide you with advice based on your financial situation and goals after completing an online survey. This data is used to invest for you automatically.”

A trader works on the trading floor at the New York Stock Exchange (NYSE) in Manhattan, New York City, on April 11, 2022. Andrew Kelly/Reuters

The Safety Dance

Is s-a-f-e-t-y a priority when it comes to your money? If so, you might want to check out a fixed annuity.

A fixed annuity can either be purchased as a single payment or as a series of smaller payments. These are called premiums. After the annuity is purchased, the company guarantees a certain amount of interest will be earned on the account.

Nevertheless, how can insurance companies make such promises? Don’t you think it sounds too good to be true?

Insurance companies typically invest premiums in high-quality fixed-income investments, such as bonds. The insurance company assumes all investment risks because it guarantees your rate of return. You also don’t have to worry about taxes until you begin receiving annuity payments, since annuities grow tax-deferred.

“During the build-up phase, interest in a fixed annuity compounds three ways: on your principal, on your interest, and on the tax dollars you would normally pay,” explains Tina Haley, a retirement products expert with American International Group.

“This commingled asset base allows the annuity company to select investments that might be unavailable to the retail investors, which is how the insurance company can justify paying returns that are commonly greater than (certificates of deposit, or CDs) or similar ‘safe’ investments,” adds Jeff Boettcher, founder with Bedrock Investment Advisors.

Fixed annuities do not fluctuate in tandem with equity markets, unlike variable and indexed annuities.

“Right now, some fixed annuities make an attractive alternative to both bonds and CDs in a portfolio, due to the principal guarantees and interest rates offered,” says William Stack, a financial advisor at Stack Financial Services.

The Game

Do you want to play the stock market game? One option, which has already been alluded to, is a variable annuity.

In contrast to fixed annuities, which carry little risk and offer a fixed rate of return (typically less than CD rates), investors can increase their retirement savings by investing in equity markets through variable annuities.

Investors are not able to invest directly in individual stocks. But, you can buy and sell shares of mutual funds. These are held in the underlying account and are referred to as the sub-account of the annuity consisting of stock mutual funds, bond mutual funds, and money market funds.

Within the sub-account, the performance of mutual fund shares determines the rate of return of the annuity. Variable annuities are considered risky compared with fixed annuities due to the inherent volatility of the stock market.

A Little Bit Country, A Little Bit Rock ‘N Roll

Indexed annuity owners can earn higher returns than other types of annuities. However, that’s only when markets are strong. Furthermore, they guard against market drops.

In short, indexed annuities offers higher returns then fixed annuities. But, they’re not as risky as variable annuities.

Indexed annuities can also be funded with a lump sum payment or by steady payments over time, just like any other annuity. And you can choose when to begin withdrawing.

You also have the power to select the index, such as the S&P 500. This index is where the annuity company invests your money. If you want to, you can spread your investment over several different indexes.

It’s also important to know how an indexed annuity rate is calculated. The gain is usually based on the index you selected over the past year. Alternatively, it may be based on its average monthly gain over the past year.

There are some drawbacks as well. One thing to consider is that you may not always receive the full benefit of index increases.

The potential gain on an index annuity may be limited to a certain percentage too. This is called the “participation rate.” If the participation rate is 100 percent, your account will receive all gains. Occasionally, it’s as low as 25 percent. Usually, indexed annuities offer a participation rate somewhere between 80 percent and 90 percent.

Consider an index with a 15 percent gain and a 80 percent participation rate. The credited yield is 12 percent. Pretty good, huh? There’s nothing unusual about indexed annuities having a high participation rate in the first few years. But, the rate may decline eventually.

An indexed annuity is also tax-deferred. As with a 401(k) or IRA, all of your investment returns grow tax-deferred until you take distributions.

Riders on the Storm

If you have a variable annuity you’ll find that the sub-accounts operate like mutual funds. As such, many contracts now include living benefit riders. The rider provides benefits to the insurance policy or changes its terms so that the coverage is reduced or restricted. The rider will cost extra since it’s often as added benefit.

A guaranteed minimum withdrawal benefit and a guaranteed minimum income benefit are popular riders. A GMWB rider guarantees the return of premiums paid, regardless of the performance of the underlying investments. In GMIB contracts, the right to annuitize is guaranteed regardless of the performance of the underlying investments.

There are additional costs and timeframes for both types of riders to get exercise and recoup their costs. During volatile stock market times, salespeople will push these and similar contract options on you.

Surrender

Each year, you’ll get a statement from your insurance company showing your annuity’s value. A few might be hard to read, so you might have to contact the annuity company for an explanation. An annuity’s surrender value is what you paid plus any investment income you’ve accumulated to this point, minus any withdrawals you’ve already made. The surrender charge could also be substantial depending on how long you’ve owned the annuity.

Additionally, annuities are more expensive to administer than other investments. Insurance companies pay investment managers to handle your money, and they pay underwriters to figure out how long you’ll live. Most of the time, the broker is also paid a large commission up front.

When you want to cash out your annuity during your first few years, the company can levy steep surrender charges. During this period, surrender charges may reach as much as 10 percent. Usually after eight years, they will disappear, but in the meantime, they will drain your funds.

Concept of annuity. Panchenko Vladimir/Shutterstock

Frequently Asked Questions About Annuity Investing

What is an annuity?

In an annuity contract, you and the insurance company agree to certain terms. An insurer will guarantee you a fixed income stream in return for a lump sum or series of premium payments.

An insurance payout may last for a limited period of time or for the rest of your life. Like pensions, annuities are often used to provide retirement income.

Why invest in an annuity vs. a mutual fund?

The following factors should be considered when deciding between annuities and mutual funds.

Market conditions determine mutual fund allocations. If conditions are favorable, they may offer a higher rate of return, but they are also associated with a higher level of risk.

A guaranteed stream of income, however, regardless of market conditions, is provided by annuities. The funds also grow tax deferred over the years.

Can I lose principal in an annuity?

Potentially.

Your principal, the money you give to the insurer to fund your annuity, is guaranteed with fixed annuities. You can protect your initial investment with fixed index annuities when the market is bad.

According to the U.S. Securities and Exchange Commission, variable annuities carry the risk of losing money, including the loss of the original investment. This is because the value and returns of a variable annuity are dependent on the investment options you choose. Poor investments may result in loss of capital.

Shutterstock

What is market value adjustment?

According to market conditions, a market value adjustment can increase or decrease interest caps and rates on fixed index annuities.

Is it wise to invest in annuities?

The main purpose of annuities is to provide long-term retirement income. In fact, a two-year contract is the shortest contract length available.

However, an annuity may not be the best choice if a consumer wants a short-term, 100% liquid retirement plan.

By John Rampton

The Epoch Times Copyright © 2022 The views and opinions expressed are only those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.