Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession variable annuities pose much more risk than fixed annuities because they are tied to market indexes, which recessions tend to pummel. Fixed annuities, by contrast, offer guaranteed rates of return.

Though fixed annuities provide peace of mind during recessions, they tend to underperform, at least compared with their variable counterparts, when the economy is doing well. During good times variable annuities reward investors willing to shoulder higher risk by providing, on average, more-aggressive returns.

Key Takeaways

  • A variable annuity, regulated by the Securities and Exchange Commission (SEC), is a retirement product in which funds are directly tied to the market.
  • A fixed annuity is a retirement product that earns a fixed interest rate.
  • The value of a variable annuity fluctuates and poses the greatest risk to an investor during a recession.

How Annuities Work

Annuities are niche investment products often used for retirement planning. Unlike most investment vehicles, annuities do not come from traditional wire houses or brokerage houses. They are managed by life insurance companies, and the person most likely to sell you an annuity is not a stockbroker but an insurance agent.

When the annuitant reaches age 59½, some annuities begin paying out its cash value through a series of fixed payments. Depending on how the annuity is set up, the payments might occur every month for five years, 10 years, or the remainder of the annuitant’s life.

Annuities are popular because they provide a sort of salary during retirement. Once you start taking distributions, you receive a regular check, always for the same amount.

Annuities are popular because they provide a steady stream of income during retirement, often until death.

Fixed vs. Variable Annuities

The defining characteristic of a fixed annuity is that during its interest-accumulating phase, the rate of interest you earn is guaranteed. In this regard a fixed annuity is more similar to a certificate of deposit (CD) than it is to a stock or mutual fund.

Also, because of this feature, fixed annuities are not classified as securities. Therefore, the Securities Exchange Commission (SEC) does not regulate them, and a person who sells them is not required to maintain a Series 7 or Series 63 license. Life insurance agents, most of whom are not licensed to sell securities, love to sell fixed annuities, in no small part because the commissions are huge.

A variable annuity is so named because its interest rate varies based on the investment tool to which it is tied. Most variable annuities are invested in mutual funds, which are bundles of stocks, bonds, and money market instruments. Because these investment vehicles, in particular stocks, vacillate based on economic conditions, variable annuities expose you to risk during recessions.

During a variable annuity’s accumulation phase, if all goes well, your balance will increase due to interest. However, when a recession hits, your balance may decline if the investment vehicle in which it is parked contracts in value. While fixed annuities do not pose this risk, they also do not grow your balance as much during good economic times.

Advisor Insight

Dan Stewart, CFA®
Revere Asset Management, Dallas

How annuities perform in a recession depends on the type of annuity and its investment strategy. For instance, if you are invested in an equity-indexed annuity and the stock market tanks, you will likely earn only the guaranteed minimum interest with very little gains.

On the other hand, if you have a fee-only annuity, which is free of commissions and surrender penalties, you have a lot more options, such as moving the capital into investments that perform well in a recessionary environment or using some of the money for short selling. As for the insurance backing the annuity, it is generally safe no matter the market backdrop, as the insurance industry is highly regulated and required to hold a certain amount of reserves to meet liabilities.