How to Define an Annuity and Looking at the History of this Often-Misunderstood Investment

How do you define an annuity and what separates it from other investments? An annuity is a financial product that divides your contributions into a revenue stream for the rest of your life. There are many different types of annuities. These investments are popular due to the investor having a guarantee of stable income for […]

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How do you define an annuity and what separates it from other investments? An annuity is a financial product that divides your contributions into a revenue stream for the rest of your life. There are many different types of annuities. These investments are popular due to the investor having a guarantee of stable income for the remainder of their life.

The annuity is not a new investment. It actually can trace its origins back to Roman times. These investment contracts were known as annua (or annual stipends) and it required Roman citizens at the time to make a one-time payment to the annua, and in exchange, they would receive lifetime annual payments in return.

In the 17th century, other European countries began to continue and/or expand on the Roman concept of annua into a group investment fund. Annuities were used as fundraising vehicles for European governments which required revenue to pay for multiple massive, ongoing wars with neighboring countries. These countries created what became known as tontine contracts.

A tontine is an investment in which participants bought shares in a common retirement fund, and in return, the participants received an annuity which increased in value every time a participant died and with the entire fund eventually going to the final survivor of the fund. The governments who offered tontines would promise to pay participants for an extended period of time if its citizens purchased the shares.

Annuities first became available in the U.S. in the 18th century. A company in Pennsylvania was formed in 1759 to benefit Presbyterian ministers and their families. Ministers contributed to the fund, and in turn, received lifetime payments.

However, it wasn’t until the year of 1912 that Americans could purchase an annuity individually (as opposed to purchasing an annuity as part of a larger group or company).

Once again, a company in Pennsylvania, called The Pennsylvania Company for Insurance on Lives and Granting Annuities, was the very first American company to offer annuities individually to the general public.

Annuities still were obscure offerings until the Great Depression in the 1930s. Many investors had concerns about the overall health of the financial markets and instead looked to safer products such as annuities offered by insurance companies, which were seen as more stable institutions.

“Saving for a rainy day,” became the mantra of the citizens of the U.S., and annuities took off in popularity. Annuities offered investors a guaranteed return on their principal investment and a fixed rate of return from the insurance company during the accumulation period. Once the accumulation period was over, the investor could choose to withdraw from the annuity in its entirety, or they could choose to receive a fixed retirement income for life drawn from the annuity principal.

Another reason for the rise in popularity with annuities was their tax-deferred status, which allowed investors to accumulate in growth without taxes being owed at the end of the year.

Up until 1952, annuities were only available as fixed products with fixed returns. A fixed annuity is an annuity that offers the investor a specific guaranteed interest rate over the entirety of the contract.

But in 1952, the variable annuity was introduced. A variable annuity offers the investor a variable interest rate of return. The value varies based on the performance of an underlying portfolio of sub-accounts.

Since the introduction of variable annuities, more and more features were added to annuities which included bonus rates for signing up, shorter maturity periods, and added “income riders” which offered a variety of additional add-on features to the annuities.

LIMRA, an independent service that tracks the insurance industry, reported that prior to the pandemic, variable annuities had spiked in sales through 2019, as investors who witnessed their retirement nest eggs devalued in 2008 and viewed annuities and the income guarantees as safe and favorable options.

Other studies also point to annuities being a hot commodity. The Secure Retirement Institute (SRI) stated in a 2020 study that “more than half (56%) of U.S. workers are interested in investing in a guaranteed lifetime income option within their employer’s retirement savings plan if it was available to them.” The study also concluded that “Of those who are currently saving in their employer’s defined contribution (DC) plan, 61% say they would be somewhat or very likely to contribute to a guaranteed lifetime income investment option.”

The SRI study found that younger workers are more open to guaranteed lifetime income investments such as annuities. Nearly two-thirds (64%) of Gen Z/Millennial workers aged at least 18, said they are somewhat or very likely to contribute to this type of option, compared to only 52% of Gen X/baby boomer workers.

The draw for young workers can be traced to the fact that many of them do not have access to pensions and would thus benefit from lifetime income products such as annuities. Less than one in five workers aged under 50 have access to pensions.

Nearly 40% of workers interviewed in the SCI study considered the financial security of lifetime guaranteed income and the knowledge of exactly how much income they’ll receive in retirement as being the top reasons listed that they were interested in annuities.

Despite the pandemic, annuity sales rose in the first quarter of 2021. Total annuity sales totaled $60.9 billion, which is a 9% increase from the same period of 2020.

Fixed-rate deferred annuities and registered index-linked annuities (RILAs) were the main drivers of the increase in annuity sales as each saw purchases rise by 46% and 89% respectively.

In the first quarter of 2021, total variable annuity (VA) sales were $29.9 billion. That’s not only a 15% increase from the prior year.  More promising is that this was the highest quarterly VA sales recorded since the fourth quarter of 2015. It’s being predicted that VA sales will grow as much as 9% in 2021. And, if that trend continues, there will be continued positive growth in this market through 2025.

Traditional VA product sales have gradually improved, quarter over quarter, since the second quarter of 2020. However, these numbers still dropped by 2% lower than the first quarter 2020 results to $20.7 billion.

Many experts point to these investments to continue to rise in popularity as more and more people are wary of the financial markets.

In a new report, “Fixed Annuity Distribution In 2020,” Jack Marrion, president of St. Louis-based Advantage Compendium Ltd., forecasts that Boomer demand for lifetime income guarantees will strengthen and that the securities industry will attach these benefits to investment vehicles with minimal insurer involvement.

Marrion states that “…more fixed annuities will be purchased in the next ten years than ever before because the fixed annuity value proposition will find a receptive ear in the 57.7 million people that are currently between ages 55 and 75. Fixed annuities, through creative uses of living benefits, will finally be embraced by the financial community and be used to offer protection against the major uncertainties of retirement.”

Marrion also predicts that banks and wirehouses will begin offering multi-year guaranteed rate annuities (MYGAs), Wall Street may create synthetic annuities to perform these functions rather than using insurance company products, 1035 exchanges will decline, and securities regulators will supervise the fixed annuity markets.

It is safe to say that the annuity, an investment with its roots in 17th century Rome, has and will continue to stand the test of time. Expect the annuity to continue to grow in popularity and become a more modernized investment in the 21st century.

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