Congress may be stalled out, but President Joe Biden is busy trying to make good on his campaign promise of combatting junk fees for the average American. His most recent initiative? Putting an end to a popular retirement strategy — the fixed index annuity. Read on to learn more about this type of annuity and what Biden’s latest move might mean for you.
Traditionally, retirement savers have had to choose between capturing growth in financial markets in an investment account and having predictable income streams after leaving the workforce. Fixed index annuities offer an alternative, allowing investors to maximize earnings on pre-retirement dollars and have reliable cash flows in retirement — but the costs can be steep.
The basics of a fixed index annuity are straightforward. While a traditional annuity offers a low, steady growth rate on invested dollars, an indexed annuity ties that rate to the return of a certain index, such as the S&P 500. These products often guarantee a rate floor, meaning that even if the market goes down, savers are protected from losing money. For some savers, the appeal of predictable retirement income without forgoing the returns of the stock market can be very attractive.
But, as with many financial products, the devil is in the details. Many indexed annuities put limits on earnings and charge high commissions. And provisions of certain products can be more detrimental to buyers, such as requiring lock-up periods which could tie up a saver’s money for years.
A major priority of the Biden administration has been reducing so-called junk fees that Americans face, and this proposal is the latest effort to follow through on that goal. At a high level, the Retirement Security rule promises to expand current securities regulations to include insurance products such as indexed annuities.
Offering high growth potential and a guaranteed floor to savers is very risky for annuity issuers, which are typically recouped in a few different ways. Most commonly, issuers will not offer savers the full rate that an index returns, either by offering a participation rate or an outright cap on the rate they’ll offer in a given year. Additionally, the commission rates on many of these products can exceed 7%, much higher than alternative market capturing investments such as indexed ETFs.
Annuities make up a large chunk of Americans’ retirement savings, with nearly $50 billion of fixed-income products being sold in the first half of 2023 alone. This means that high commission rates and participation discounts can add up to a significant drag on American savers. Biden’s plan is more ambitious than just curbing indexed annuities, and includes expanding securities laws to non-investment products and expanding fiduciary duties to insurers.
If the rule comes into effect, Americans could see substantial changes to the products they’re using to save for retirement. While specific details are yet to be ironed out, the expansion of fiduciary rules to insurers could provide savers with greater transparency and lower costs when it comes to annuity products. The Department of Labor will open the proposal to public comment for 60 days, including hosting a public hearing.
Fixed index annuities can offer retirement savers steady income in retirement while allowing participation in financial markets, but those benefits come at a cost. Common costs associated with the products are limited upside potential and high commissions. Biden’s Retirement Security rule is not a foregone conclusion, and savers should keep an eye on the progress of the Department of Labor before making any changes to their retirement plans.
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