Annuity Stability in Market Crashes
Nobody can ever predict what the stock market will do in the future. If you have an annuity or are thinking about getting one, what can happen to your annuity if the stock market crashes? Will the market downturn impact your annuity? The short answer is that it depends on the type of annuity that you have. Other factors can come into play as well.
In this article, we will cover what can happen to your annuity when the stock market crashes. Keep in mind the five primary annuity types as you read this guide on annuities and market crashes: immediate annuities, fixed annuities, multi-year guarantee annuities (MYGAs), fixed index annuities, and variable annuities. As you will see, only the last two types of annuities can be affected by a stock market crash.
What Happens to a Fixed Annuity if the Stock Market Crashes?
If you have money in fixed annuities when the stock market has a major correction, then you don’t have to worry about losing money in your fixed annuity. None of the money that you gave your insurance company is invested in the stock market. You won’t lose any money, regardless of what the market does.
Life insurance companies invest the premiums that they receive for fixed annuities in a portfolio of bonds and other conservative, income-producing instruments. The insurance company is required by law to maintain enough cash reserves and cash-equivalents to cover every dollar of outstanding fixed annuity premium that it has issued.
What Happens to a Multi-Year Guaranteed Annuity if the Stock Market Crashes?
In a nutshell, multi-year guaranteed annuities (MYGAs) are just as safe as traditional fixed annuities when it comes to market crashes. Multi-year guaranteed annuities guarantee both the principal and interest earnings to annuity owners, irrespective of how the stock market performs.
MYGAs may be less to worry about than fixed annuities in the respect that their interest rate is guaranteed for the entire term. With fixed annuities, you may get the quoted rate of interest for a period of time that is less than the full term of the contract.
For example, you might buy a fixed annuity with a 10-year period and an initial interest rate of 4%. But this rate may only last for a few years and then reset to a higher or lower rate, depending upon where interest rates go.
In contrast, a MYGA will pay a guaranteed effective yield for the entire term of the annuity, regardless of what the markets or interest rates do. For example, you may have a MYGA with a guaranteed effective yield of 5% for four years. That means that you will receive 5% per year for that entire term.
This can make it easier for you to plan ahead with your money, knowing exactly what you will get and for how long.
What Else to Know About These Annuity Types and Market Crashes
For the three types of annuities just listed here, insurance companies handle the guarantees that they make to their policyholders in the same way. When the insurance company calculates your payout amount, it accounts for its long-term obligations, its financial resources to support that, and how it expects those to perform.
These calculations take the possible effects of a stock market crash into consideration, so you won’t have to worry about this.
What if the Value of My Life Insurance Company’s Stock Falls?
If the stock of a life insurance company that issues fixed annuities goes to zero and the company becomes insolvent, then reinsurance companies would step in to reimburse all the insolvent company’s policyholders up to certain limits, such as $300,000 per contract.
If the reinsurance companies don’t have sufficient reserves to cover everyone, then the state insurance commissioner steps in with other resources.
Say that you have a large amount of money that you want to put into annuities, and you worry about the possibility of your insurance company becoming insolvent. While life insurance companies have a very impressive historical record of upholding financial protection for millions of people in numerous different economic and market conditions, no financial institution is immune to failure.
If you are still worried about this possibility, you might consider breaking that money up and putting it into several different annuities. You might even consider multiple annuities from more than one insurer. This way you can rest assured that you have a better chance of getting your money back if the life insurance company did become insolvent (and the risk is also spread out with the other annuities).
It’s also good to look up a given insurance company’s financial strength rating before you buy anything from them. If they have a rating of BBB+ or higher, then that is an indicator of their financial strength and how much they have in stock to make good on their contractual promises.
Interest Rates, Insurance Companies, and Annuity Guarantees
Not only that, the interest rates and guarantees that life insurance companies make on their fixed products are much more dependent upon current interest rates and bond prices than they are on stock market performance.
When interest rates are high, then insurers can generate more income from their investments and thus offer more competitive products with higher rates and better guarantees. When interest rates are low, then these guarantees (such as the amount of income paid out of an immediate annuity) will decline.
If you started to get your payout from an immediate annuity when rates were high, then you can still count on getting your full payment every month, even if rates are now much lower (as they have been for the past several years). Your payment is guaranteed and won’t be affected by subsequent changes in interest rates.
This type of guarantee is one of the reasons why annuities have become so popular with retirees. They can count on receiving a guaranteed stream of income that is unaffected by market crashes or other economic factors that can substantially impact the performance of other types of investments, such as stocks and stock mutual funds.
What Happens to a Fixed Indexed Annuity if the Stock Market Crashes?
Fixed indexed annuities can be looked at as a kind of “happy medium” between the three previous types of annuities discussed and variable annuities. Whereas fixed annuities and MYGAs pay a guaranteed rate of interest, fixed index annuities credit interest that is linked to an underlying financial benchmark, such as the S&P 500 price index.
When the index rises in value during a certain period, then the insurer will credit the annuity with interest earnings that is based on a portion of that growth. If the index declines in value, then no interest will be paid for that crediting period. But that is the only type of “loss” that you can have with a fixed indexed annuity.
Your principal is always guaranteed against index losses, regardless of how the benchmark index performs. What’s more, fixed indexed annuities don’t pay guaranteed interest as fixed annuities or MYGAs do, but they have earned more interest, on average, over time than these kinds of annuities.
Here is another thing to keep in mind. While you may not earn any interest in one crediting period, you might make up for it in the next one.
For example, say you buy an indexed annuity on January 1st of a certain year, when the S&P 500 was 4696. Your indexed annuity credits interest once per year on your contract anniversary date. So, if the index drops to 2000 by January 1st of next year, then you won’t earn any interest for that period.
But say that, instead, the index goes up to 4900 by January 1st of 2024. You will be credited with all the interest based on a portion of that index growth.
If you owned an S&P 500 index mutual fund, you would have to wait for the index to come all the way back to 4696 before you could make any more money. If the index rises to 4900, you will only get the difference between that and 4696.
However, with the indexed annuity, the contract reset on January 1st, so your basis for receiving interest will start at 2000. Does that make sense?
The interest that is credited is always based on the index’s value at the beginning of the crediting period to the end of it.
What Happens to a Variable Annuity if the Stock Market Crashes?
Finally, what happens when the market crashes and you have money in a variable annuity contract?
Unlike fixed, immediate, MYGA, or fixed indexed annuities, it’s possible to lose money in a variable annuity. This is because the money that you put into a variable annuity isn’t placed into the insurance company’s general cash reserves (as the prior-mentioned fixed-type annuities are).
It’s instead invested into mutual fund subaccounts that invest in stock, bond, and real estate markets. The value of these subaccounts will rise and fall depending upon market performance.
So, that means that if the market has a severe correction, you may see the value of your annuity money take a big hit. And unlike with an indexed annuity, your gains won’t reset at their current lower level, so you will have to wait until your annuity makes up for these losses before you will make any more money.
Of course, virtually all variable annuities offer some relatively lower-risk investment alternatives, such as money market funds and fixed accounts. In some cases, the fixed account option in a variable contract may pay more interest than the fixed annuities offered by the same insurer. Should you have money in a fixed account inside a variable annuity, that money will be shielded from market crashes just as if you had it in a fixed contract.
Most variable annuities also offer guaranteed income riders that can pay you a guaranteed income that isn’t tied to market performance. The way these riders work, you can draw a stream of income based upon a hypothetical, promised rate of growth instead of the actual contract value.
So, say you put $100,000 into a variable annuity and opt for a guaranteed income rider with 7% growth. You let the annuity grow for 10 years and then the markets drop by 25% the year before you’re ready to retire.
The guaranteed income rider will kick in and give you a payout that is based on 7% compounded growth over the past 10 years instead of the actual contract value. This type of guarantee can be a nice deal for those who are planning to take a stream of income from their annuity in retirement.
Some Final Thoughts on Annuities and Market Crashes
As you can see, many annuities are largely shielded from stock market crashes, except for variable contracts. Even so, variable annuities usually have some safeguards built into them for guaranteed income to cushion this risk.
Just be sure to find out what the costs and fees are for any annuity that you buy. There are typically no explicit fees of any kind with fixed annuities, MYGAs, and immediate annuities.
Fixed indexed annuities may have optional income riders or rate enhancement fees that you can pay for additional guarantees or potentially higher growth. For example, a fixed indexed annuity might have an income rider benefit that costs you 0.95% per year.
In crediting periods when the index is down and your annuity earns zero percent, the rider fee might override the zero-percent credit, in which case your money might see a small dip in value. Keep that in mind if you have any rider benefits that are part of your fixed index annuity contract.
Variable annuities are typically the most expensive type of annuity you can buy. These contracts have annual administration fees, investment management fees, rider charges, and other costs that can push your costs to 3% or more per year.
Your financial advisor can tell you what you are paying if you are unsure of where to find this information.
Conclusion
Generally speaking, you don’t have to worry about market crashes affecting fixed index annuities, unless you have a rider benefit with an annual fee that might offset a zero-percent credit in down-index periods. Otherwise, you won’t lose money in a fixed indexed annuity when the index falls.
Fixed annuities, MYGAs, and immediate annuities aren’t affected by market crashes. They will continue to earn interest or provide you with guaranteed payments, as you are contractually entitled to.
Variable annuities are the odd man out when it comes to market crashes, however. You can lose money in subaccounts when markets don’t perform well. But you also have the most growth potential with a variable annuity because of that market exposure.
Consult your financial advisor for more information on annuities and how they can benefit you. If you are looking for a financial professional to help you, you might consider working with someone who is experienced, qualified, and operates an independent practice, meaning they aren’t beholden to a parent financial company.
If this sort of guidance sounds appealing to you, many experienced, independent financial professionals are available here at SafeMoney.com. You can get started by using our “Find a Financial Professional” section and connecting with someone there directly. In your first meeting, you can discuss your goals, concerns, and situation. Should you want a personal referral, please call us at 877.476.9723.
