While most experienced agents and advisors know a great deal about annuities, newer financial pros just starting to work with annuities may not know about all their advantages. And it doesn’t hurt for experienced agents to have a refresher.
(Related on ThinkAdvisor: Fixed annuity sales hit record $117.4 billion in 2016)
Clients can lose money in bonds. The market value of a bond fluctuates with changes in interest rates. If rates go up and the client sells a bond prior to maturity, it will be worth less than its original cost. With an individual bond, the client can avoid this problem by holding it to maturity.
But investors in bond funds don’t have that option. If rates spike up after the client buys a fund, the value will decline. Especially with a long-term bond fund, they may never recover their full principal.
Owners of individual bonds (except Treasuries) also face default risk. A company or municipality may run into financial problems and fail to make timely interest or principal payments. A default means the client could lose part or all of the investment.
In contrast, an annuity is guaranteed by the issuing insurance company. While state regulators constantly monitor the financial strength of insurers, in a severe financial crisis it’s possible that an insurer could fail. That’s why state guaranty associations provide an additional level of protection.
With fixed annuities, the insurance company bears the underlying investment risk, shielding annuity owners from both bond market volatility and default risk.
Bonds normally pay earnings every six months. With most individual bonds, the client can’t reinvest interest so that it can grow and compound.
Bond funds let the client reinvest the dividends automatically, but the price per share varies as interest rates change. The client may have a gain or loss on reinvested dividends when the client cashes in the fund.
Fixed annuities let the client reinvest interest earnings without risk. Reinvested earnings earn the same rate as the base annuity, so the yield is guaranteed. Contract owners who need income can choose to receive interest earnings monthly, quarterly or annually.