Like most investments, annuities carry a risk of loss. Annuities are insurance contracts generally intended to provide income during retirement. You can fund an annuity with a lump sum or contribute to it in varying amounts over time. Fixed annuities can be structured to minimize risk with conservative, fixed interest rate returns. In contrast, variable annuities invested in equity or bond markets, have a greater potential to expose your portfolio to losses.
Stock Fund Annuities
Annuities may be invested in stock mutual funds that are professionally managed baskets of equities. Mutual funds may be sector specific, such as technology, health care or utility funds. Or, they may be broad based, tracking indices for things like the Dow Jones Industrial Average or the S&P 500. These funds, classified as variable annuities, have the potential for large gains if your investment class excels, but can also suffer losses in market declines.
Bond Fund Annuities
Annuities can invest in bond funds which are baskets of various corporate, federal, state or municipal debts. Bond funds differ from individually purchased government bonds, which generally guarantee principal investment. Shares in bonds funds fluctuate and may be lower at the time of retirement than when purchased. Bonds generally decrease in value when interest rates rise. Fund managers may sell bonds in different market conditions, before maturity dates, and may invest in higher risk, corporate debt that can trigger losses.
Fixed Income Annuities
Fixed income annuities protect investors from market volatility. They provide guaranteed interest rates and offer predictable growth for planning. The risk of a fixed rate annuity is that it may not keep pace with inflation. Annuities with flat or low growth can jeopardize retirement goals by turning out lackluster income streams. Some interest-rate-only annuities curb this risk by setting minimum, guaranteed rates of return while allowing payable rates to float upward if market interest rises.
Insurance Company Insolvency
Annuities are not guaranteed by the federal government's Federal Deposit Insurance Corporation. However, if an insurance company becomes insolvent, state governments generally provide guaranty funds or guaranty associations to prevent annuity losses. Coverage varies widely from state-to-states. For example, Alaska provides a $100,000 safety net. Wisconsin provides $300,000 in coverage and New York rings in at $500,000. Annuities with values exceeding state coverage amounts may incur losses if their issuing insurance companies go bankrupt.
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- U.S. Security and Exchange Commission: Annuities
- Financial Industry Regulatory Authority, Inc.: Variable Annuities: Beyond the Hard Sell
- Federal Deposit Insurance Corporation: Deposit Insurance Summary
- Insure.com: What Happens When Your Insurance Company Becomes Insolvent
- Annuityadvantage.com: State Guarantee Funds
- American Association of Individual Investors: How Interest Rate Changes Affect the Price of Bonds