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 caused by taxes and the fiduciary rule. If you own an annuity or are considering it as part of your retirement portfolio, understand how regulatory changes could affect you.
What is an Annuity?
An annuity is an investment tool that guarantees income for life. You may choose from five types of annuities.
- Fixed – pays a set interest rate and is usually issued by an insurance company
- Variable – account value changes based on the returns of the mutual funds the investor chooses
- Indexed – variable interest rate is added to your contract value
- Immediate – pays distributions right away
- Deferred – earn fixed or variable interest and delays distributions by at least a year
Why the Change in Annuity Recommendations
According to the survey conducted by Financial Planning Association, the Journal of Financial Planning and Longboard Asset Management, financial planners are less likely to recommend fixed, variable and indexed annuities this year. The causes are taxes and the fiduciary rule.
Annuities are tax-deferred, which means you don’t pay taxes on contributions but will pay taxes on distributions. While this tax savings is attractive, it is not free. Capital gain distributions from annuities are taxed at a higher rate than ordinary income. You could pay more taxes in the long run when you invest in certain types of annuities.
According to the Department of Labor’s fiduciary rule, all financial professionals who work with or recommend retirement products are considered fiduciary and legally bound to meet ethics standards. Previously, only financial advisors who charged hourly or percentage fees were considered fiduciary.
This rule prompts financial planners to reveal accurate fees, taxes and other charges. While they don’t have to recommend only the products with the lowest fees, they can no longer recommend products that may yield high returns for them and lower returns for the investor, such as various types of annuities.
How Do These Annuity Changes Affect You?
Because of the taxes and fiduciary rule, financial planners are beginning to recommend investment options other than annuities. Those options include mutual funds, exchange-traded funds and cash equivalents.
While these options do not feature tax-deferral benefits like annuities, their capital gains are taxed at a lower rate than annuity distributions. Investors could receive more money per distribution when they select one of these options.
How to Navigate Annuity Changes
As an investor, you will want to talk to your financial planner about the regulatory changes that affect annuities. You may wish to pursue alternative investment options as you reduce your tax burden and maximize your savings.