A recent investment trend survey reports that financial advisors are changing the financial products they recommend to investors. This change primarily affects annuities and is driven by taxes and the fiduciary rule.
If you own an annuity or are considering one as part of your retirement portfolio, understand how regulatory changes could affect your choices.
What is an Annuity?
An annuity is an investment tool that guarantees income for life. You may choose from five types of annuities.
- Fixed Annuities - pays a set interest rate and is usually issued by an insurance company.
- Variable Life and Annuities - account value changes based on the returns of the mutual funds the investor chooses.
- Indexed Annuities - a variable interest rate tied to an index is added to your contract value.
- Immediate - pays distributions right away.
- Deferred - earn fixed or variable interest and delay distributions by at least a year.
Why the Change in Annuity Recommendations
According to a survey conducted by financial planning organizations, financial planners are less likely to recommend Fixed Annuities, Variable Life and Annuities and Indexed Annuities this year. The primary causes cited are tax treatment and fiduciary responsibilities.
Taxes
Annuities are tax-deferred, which means you don't pay taxes on contributions while the contract grows, but you will pay taxes on distributions. While tax deferral is attractive, some annuity distributions are taxed as ordinary income rather than at lower capital gains rates, which can increase the total tax paid over time for certain annuity types.
Fiduciary Rule
The fiduciary standard requires financial professionals who recommend retirement products to act in the client's best interest and to disclose fees, taxes and other charges. This standard applies broadly to advisors who work with retirement accounts.
Under the fiduciary standard, advisors must avoid recommending products that generate higher compensation for the advisor at the expense of lower net returns for the investor, which has reduced some advisors' use of certain annuities.
How Do These Annuity Changes Affect You?
Because of tax considerations and the fiduciary standard, many financial planners are recommending alternatives to annuities, such as mutual funds, exchange-traded funds (ETFs) and cash equivalents.
These alternatives do not offer the same tax-deferral feature as annuities, but capital gains from taxable accounts are often taxed at lower rates than annuity distributions, so investors may receive more net money per distribution with these options.
How to Navigate Annuity Changes
Talk with your financial planner about how taxes and fiduciary responsibilities affect any annuity you own or are considering. Review fees, surrender charges, tax treatment and how a product fits your retirement income needs.
If you want to review product options or compare alternatives, consider scheduling time to talk to your agent about your situation.
Frequently Asked Questions
How are annuity distributions taxed?
Distributions from tax-deferred annuities are generally taxed as ordinary income when withdrawn, which can differ from lower long-term capital gains rates on taxable investments.
Does the fiduciary rule prohibit annuities?
No. The fiduciary standard does not ban annuities, but it requires advisors to recommend products that are in the client's best interest and to disclose conflicts and fees.
Can I keep an annuity I already own?
Often you can keep an existing annuity, but it's wise to review its fees, tax consequences and surrender terms with your advisor to see if it still fits your plan.
What investment alternatives do advisors commonly suggest?
Advisors commonly suggest mutual funds, ETFs and cash equivalents as alternatives because their capital gains are often taxed differently and they can have lower ongoing fees.