Is an Annuity a Security?

Most annuity products are not considered securities. The exceptions are two types of annuities — variable and registered index-linked annuities (RILAs). Traditional fixed annuities are not classified as securities. That’s because they offer a fixed and guaranteed rate of return during the accumulation phase and in the distribution phase.

It's essential to understand the specific features and provisions of an annuity contract and, if appropriate, consult with a financial professional to determine whether it is a security or not. Before we delve into the details of annuities and securities, let's define the term "security."

What is a Security Anyway?

At a basic level, a security is a financial asset or instrument that has value and can be bought, sold, or traded.

Some of the most common examples of securities include stocks, bonds, options, mutual funds, and exchange-traded funds (ETFs). One of the key attributes of securities is risk.

Securities are subject to various types of risk. The specific risk associated with a particular security depends on the type of security and the underlying assets it represents. For example:

• Stocks (Equity Securities): Investing in stocks carries market risk, company-specific risk, and market sector-specific risk. The value of stocks can fluctuate significantly in response to changes in economic conditions, company performance, and consumer sentiment.
  
  
• Bonds (Debt Securities): Bonds can be exposed to interest rate risk, credit risk, and risk associated with the issuing entity. Changes in interest rates can impact the value of bonds, and there is a risk that the issuer could default on interest or principal payments.

Variable annuities and RILAs use securities or security indexes like the S&P 500 index as underlying investments. These securities can help grow the balance of your annuity or, conversely, can reduce the value of your annuity if the securities within the annuity perform poorly.

Securities are regulated at the state level and are also overseen by two federal agencies, the Securities & Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

The SEC is the principal federal regulatory agency responsible for enforcing federal securities laws and regulating the securities industry. FINRA is a self-regulatory organization (SRO) authorized by Congress to oversee and regulate brokerage firms and their registered representatives.

Fixed annuities are different. The insurance company offering fixed annuities does the investing and takes on the risk while offering you a fixed, guaranteed rate of return.

So, your primary risk is the financial solvency of the insurance company and its ability to meet its financial obligations. Insurers are regulated at the state level via state insurance departments, which are responsible for items like product approvals and agent licensing.

Insurers also receive ratings from rating agencies like AM Best, Moody's, and others. These agencies provide financial strength ratings that range from "Superior" to "Poor." AM Best, for example, has seven levels of ratings. Generally, you want to do business with entities that have ratings of "good" or better.

What Kinds of Annuities are Regulated as Securities?

As we mentioned earlier, there are two types of annuities that are considered securities — variable annuities and a unique type of variable annuity hybrid called a RILA.

Here are some details regarding these products:

Variable Annuities

Variable annuities are considered securities because they allow the buyer to invest in a variety of sub-accounts that are similar to mutual funds. The performance of these sub-accounts is tied to underlying investments, usually stocks and bonds.

Variable annuities offer the potential for higher returns than fixed and fixed-indexed annuities but also come with greater risk because underlying investments can underperform, and you have the potential to lose some of your principal.

RILAs

A registered index-linked annuity, or RILA, is a type of variable annuity that combines features of fixed-indexed annuities and variable annuities.

What sets it apart from other types of annuities is the ability for you to set the maximum loss you are willing to tolerate.

They offer returns linked to the performance of an underlying index or reference benchmark, but unlike fixed-indexed annuities (FIAs), they do not guarantee the principal. RILAs provide the potential for higher returns but also come with more risk because your account value can fluctuate based on the index's performance.

When you purchase this type of annuity, you can decide how much risk you’re comfortable with and how much downside you're willing to tolerate by choosing either a "floor" or "buffer" option. A RILA floor caps your loss. It is the maximum percentage loss you are willing to absorb during a down market. A RILA buffer is a percentage of loss that the insurance company will absorb. You are exposed to losses to the extent that losses within the market index in your account exceed the buffer.

What Kinds of Annuities Aren’t Regulated as Securities?

There are three core types of annuities that do not feature an investment component or the potential for investment gains or losses tied to market performance.

These annuities are considered insurance products and fall under the regulatory oversight of state insurance commissioners.

Fixed Annuities

Fixed annuities guarantee a specific interest rate for a period of time that you choose.

The annuity provider is the investor, and you receive a guaranteed rate of return no matter how the insurer's investments perform. Fixed annuities do not involve direct participation in the stock market or other securities markets, and as a result, they are regulated as insurance products rather than securities.

Fixed-Indexed Annuities (FIAs)

Fixed-indexed annuities have some characteristics that involve the performance of an underlying index but are primarily considered insurance products.

FIAs offer a guaranteed minimum interest rate along with the potential for additional growth (usually with a maximum cap) based on the performance of an index like the S&P 500. 

Immediate Annuities

Immediate annuities are contracts where you make a lump-sum payment to an insurance company, and in return, the insurance company provides you with a stream of income payments immediately or shortly after the contract is issued.

Since immediate annuities do not involve an investment component or the potential for market-related gains or losses (once again, the annuity provider invests the money), they are generally not classified as securities.

How Can the Distinction Impact You?

Buying an annuity with an investment component can complicate the purchase for several reasons and, therefore, requires the advice and counsel of an agent with securities licenses, which include Series 7 and Series 66.

1. Market Risk: Annuities with investment components, including variable annuities and RILAs, expose you to market risk. The value of the annuity can fluctuate, so you should be comfortable with the potential for both gains and losses.
2. Confusing Features: Annuities with investment components often come with a variety of features, riders, and options. Understanding these complex features, which include living benefits, death benefits, and various riders, can be challenging. 
3. Fees and Charges: Variable annuities typically have higher fees and charges compared to traditional fixed annuities. These fees can impact the overall return on investment.
4. Surrender Charges: Annuities of all types come with surrender charges, the most punitive during the early years of the contract. Surrender charges may apply if you decide to withdraw a significant portion of the annuity's value within a specified period. Money needed in the short term should not be allocated to annuities.
5. Investment Choices: Variable annuities offer a range of investment options. You need to make investment choices based on your risk tolerance, investment goals, and market outlook. This requires a level of financial literacy and an understanding of the different investment types available.
6. Tax Treatment: The tax treatment of annuities can be complex, especially for variable annuities. Earnings within the annuity may be tax-deferred, but withdrawals may be subject to ordinary income tax and, in some cases, a 10% early withdrawal penalty if taken before age 59½. It's a good idea to speak with a tax advisor to understand the tax implications based on your individual circumstances.

Which Type of Annuity Should I Choose?

Annuities can be an integral part of your overall retirement planning strategy. They are the only product that can guarantee a flow of payments in retirement that you cannot outlive.

But there are several types of annuities for sale in the marketplace, catering to conservative and aggressive buyers.

When you purchase an annuity prior to retirement, make sure you are comfortable with the level of risk inherent in the product and ask questions regarding whether there are components that involve investing in securities.

A well-balanced retirement portfolio can certainly include traditional IRAs, 401ks, stocks, bonds, and different types of annuities, including variable annuities, RILAs, and fixed annuity products.

Final Thoughts

Annuities can be a great addition to a well-rounded retirement strategy. Some annuities feature underlying investments (securities) that can help accelerate growth but can also be complex and lose money.

Fixed annuities from Canvas provide you with a very competitive fixed rate of return guaranteed by the company. For conservative buyers, a Canvas annuity can fill an important role as part of a comprehensive retirement plan. And buying a Canvas annuity is easy! You can purchase right over the phone or get started with our online application.