Can You Lose Money In An Annuity? Know These Two Things To Figure It Out

_This article was originally posted on Forbes.com and can be viewed here._

Yes, annuities provide valuable tax-deferred growth. But for more than any other reason, annuities are valuable because of their guarantees. In an annuity, the insurer makes certain contractual guarantees that are not available in a traditional investment product.

There are two things you need to know if you’re an annuity owner or considering a purchase if you want to understand whether you can lose money. First, what kind of annuity do you own or are you considering purchasing? Second, what is the financial strength rating of the insurer?

In this article, we’ll help you gather the information needed to answer both of these questions.

What Kind Of Annuity Do You Own?

Let’s start by looking at the two types of annuities — fixed (including fixed index, fixed rate, and income) and variable annuities.

Variable Annuities

Think of the variable annuity as a mutual fund, but potentially with some contractual guarantees like the ability to withdraw a certain amount each month once you retire, no matter what happens in the underlying mutual fund investment. If you own a variable annuity without a contractual guarantee like that, you essentially just own a mutual fund that has some beneficial tax deferral characteristics. If you own one with an income-based contractual guarantee, you are holding the promise of being able to take a certain level of distributions starting at a certain age, and the insurer is required to continue letting you do that even if the value of the assets in your underlying account goes to $0. The SEC treats variable annuities as securities.

Fixed Annuities

Fixed annuities — as defined in regulatory parlance — include indexed, fixed rate, and income annuities. For a time, the SEC attempted to treat fixed index annuities as securities, but was unsuccessful in this attempt. Indexed annuities guarantee that you won’t lose money, but your ability to gain money is typically a function of the performance of market indices. You don’t actually own the market index, unlike with a variable annuity. The value of the indexed annuity will go up the better the market does (but typically not by as much as the market goes up), but it won’t go down in the case of a large market drop.

With traditional fixed annuities (sometimes also referred to as fixed rate annuities or MYGAs), you never lose money if you hold the policy to maturity and don’t withdraw early (thereby potentially incurring early withdrawal penalties). The rate you are quoted for the guarantee term when you buy the policy is exactly what you’ll get — no more and no less. The fixed annuity has a typical duration of 3-10 years, over which period the rate is guaranteed and, at the end of which period, the funds can be withdrawn or rolled over into another annuity without penalty.

In a basic life-only income annuity, the payments are a set amount and they continue at that exact level for as long as you’re alive. Although your payouts are preset and guaranteed at a specific level, you could lose money if you died younger than expected. You can protect against this unfortunate occurrence by purchasing an income annuity that includes a death benefit (a.k.a. a cash refund), which will give your beneficiary the balance of your principal that has not been returned via income payments as a lump sum upon your death.

Traditional fixed and income annuities are the only kinds of products we have on the Blueprint Income platform.

Likelihood of Losing Money

How Would You Lose Money?

Variable Annuity (investment only)

About as high as if you owned the same underlying investment outside of an annuity

• Poor investment performance
• Withdraw funds early

Variable Annuity (income rider)

Same likelihood of losing money if you’re using the product for accumulation and don’t plan to use the income rider, but less risk if you plan to use the income rider

• Poor investment performance
• Withdraw funds early
• Die younger than expected

Fixed Index Annuity

Unlikely

• Withdraw funds early

Traditional Fixed Annuity 

Unlikely

• Withdraw funds early

Income annuity (immediate or longevity)

Unlikely

• Have a life only product and die younger than expected

What Is The Financial Strength Rating Of The Insurer?

Once you’ve figured out what product you have, and therefore what the nature is of the contractual guarantee you hold, the next step is to find the insurer’s financial strength rating and decipher what that means. Almost every annuity company will have a rating from A.M. Best. Below is a summary of what those ratings mean.

A.M. Best Ratings Summary

All else equal, the higher the rating, the more likely it is that the insurer will actually be able to follow through on the contractual guarantee they make to you. I recently wrote a longer post about the financial strength ratings of annuity companies and the most important things you need to know. You can read that here.

Conclusion

Yes, it’s possible to lose money with certain kinds of annuities. All else equal, if (1) the market underperforms and you own a variable annuity (2) you have a life-only income annuity and you die earlier than expected; or (3) the insurer is insolvent and the backstop provided by the state guaranty fund doesn’t kick in (either because you’re over the per policy limit or for some other reason), then you could lose money on the annuity.

However, these are edge cases. Of the annuities discussed here, only the variable annuity without an income rider represents a similar risk of loss as owning a mutual fund or ETF of equities.

If you’re looking for a simple annuity where you know what you’ll get in guaranteed return or guaranteed monthly income at the time you buy, you’re best off going with a traditional fixed annuity (for a CD-like guaranteed return) or income annuity with a cash refund (for monthly income) from a highly-rated insurer.