Annuities are popular among insurance salespeople but earn mixed reviews from consumers. They have a long-standing reputation for being costly and complex. In the past few years, financial watchdogs have proposed tighter fiduciary standards for annuities; some changes have emerged. Are these changes just window dressing or are annuities becoming a better value?

Anyone planning their retirement should have a basic understanding of annuities. Like Social Security, you pay in money now for a guaranteed flow of funds later. In the case of Social Security, the federal government deducts a portion of your paycheck for the decades of your working life. In contrast, private annuity purchases are paid to an insurance company over a shorter period or even as a lump sum.

Social Security benefits are payable for the remainder of your life and are backed by the federal government, which has never defaulted. Annuity payments may be paid out for life or for a specific number of years. The payments are backed by the insurance company and are not insured by FDIC. For insurance companies which go bankrupt, defaulted annuitants may have some recourse through their state.

All annuities have a goal of providing you regular income.

“That’s the fundamental reason why you buy an annuity. It hedges against longevity risk,” according to financial planner and CFP Michael Menninger.

Pluses and minuses

Three main types of annuities reflect the different advantages and disadvantages of annuities.

Fixed annuities typically guarantee a specific benefit or rate of return.

Variable annuities have a rate of return which fluctuates depending on the underlying investments you choose and their performance.

Indexed annuities’ returns are based on a percentage of a specific index such as Standard & Poor 500.

Variable and indexed annuities may have a death benefit and or other riders, each of which has a fee.

The complexity arises from these many forms of annuity and the opaque effect on your investments’ safety and rate of return. Variable and index annuities in particular are complex and difficult for consumers to understand. Insurance regulators instituted a suitability standard in 2003 that sought to protect consumers from being sold annuities that weren’t appropriate for their situations.

More recently, the Financial Industry Regulatory Authority (FINRA) sought to require the higher “best-interest” standard for annuities. This federal FINRA regulation was vacated before it took effect in 2018, but states continue to push for consumers to be protected by the best-interest standard for annuities.

Federal financial laws continue to push for uniformity

In 2020 the National Association of Insurance Commissioners (NAIC) approved revisions to Model #275 in clarifying that “all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of the consumers’ interest in making a recommendation.” Arkansas, Arizona, Iowa, and Michigan have adopted the model revisions; Rhode Island’s becomes law on April 1.

While we may never witness the uniform best-interest protection that the FINRA regulation sought to provide, we may already be seeing the initial results of the states’ updates. In January, Schwab introduced two new variable annuities that are among the lowest cost in the industry. The Schwab Genesis Variable Annuity is offered directly to Schwab clients and the Schwab Genesis Advisory VariableAnnuity is available through some independent Registered Investment Advisors (RIAs). The base fee for each of these new annuities is substantially below the industry average. Other providers are likely following suit already.

How does this relate to controlling how insurance agents can describe annuities to consumers? Simply, when the agents must compare and find the best annuity for their clients, they tend to find lower priced ones even when it won’t benefit their commissions. When annuities become more readily compared, fees and commissions shrink in the new competition.

Are annuities a good value? I believe they deserve consideration in some retirement plans. Fixed annuities in particular are still exceedingly less complicated than variable annuities, so you can understand what you are getting. If you are considering an annuity, you should answer these questions:

What are you seeking in an annuity?

Is an annuity the best way to achieve that?

What portion of your portfolio would you dedicate to this investment?

If you decide on an annuity, which insurer is the healthiest and most likely to pay for the life of the annuity?

Before you sign on the dotted line, seek advice from a fee-only financial advisor. Even with the “suitability” standard that some insurers must now follow, they are not required to have your best interest in mind.

Karen Telleen-Lawton is a Certified Financial Planner in Santa Barbara, Calif.