Equity Indexed Annuities

Too good to be true? 

 

Still feeling the burn caused by the stock market downturns from the Tech bubble in 2000 and the Credit Crisis of 2008 many investors are still leery about venturing back into the stock market.  The option of parking your money in a CD earning less than 1% is not too appealing either.  Along come the Insurance companies with a product targeted specifically towards conservative investors who would like to participate in the stock market gains while not losing any money should the stock market go down.  The product is called an Equity Indexed Annuity and if it sounds too good to be true, it probably is.

The Product
 An Equity Index Annuity is a fixed annuity - it offers a guaranteed interest rate during the accumulation period, which is the time the investor invests their money in the annuity until the time that they begin to take money out of the annuity.  Unlike the more standard fixed annuity, the interest rate that the insurance company will pay you is not at a fixed rate, but it is connected to the movement of the particular underlying index to which your annuity is tied (Dow Jones, S&P 500, Russell 2000, ...) It would appear that you get the benefits of upturns in the stock market without the risk of downturns, but the fine print makes this no sure thing.

 The following are things to consider when deciding to invest in an equity index annuity:

Participation Rate
You do not actually get the full benefit of any increase in the value of the underlying index.  For example if your participation rate is 70% and your index rises 9%, you are only credited with a gain of 6.3% (.70 X 9).  You can find the participation rate within the fine print of your annuity contract.  Another problem is that sometimes the insurance company only guarantees the Participation Rate for a single year, whereas others may lock in the Participation Rate for the entire period of the Equity Indexed Annuity

Dividends
A large part of investment return of some stock indexes involve dividends.  Unfortunately there may be a provision in your annuity contract that states that dividends are not considered in determining your payment

 Interest Rate Caps
Some annuity contracts limit the return the insurance company has to pay you no matter what the index does.  For example, if your Interest Rate Cap is 10%, that is the top return you will receive even if the index is up 25%.

Fees
Margin fees, Spread Fees, Asset Fees, and Administration Fees all will eat at your returns.  Ensure that you understand all fees and costs when you compare annuities from different companies

Simple or compound Interest
It sounds simple, but whether your Equity Index Annuity pays you interest on a simple interest basis or a compound interest basis can have a significant effect on what you stand to gain.  With compound interest, the interest you earn during one period is added to the principal of your annuity; Simple interest is only calculated on the original principal.

Early withdrawal fees
If you decide you would like to cash in all or a portion of your Equity Indexed Annuity before the term of the annuity is up, you will most likely be subject to penalties in the form of surrender fees which are usually a percentage of the amount you are cashing out.  There are cases where the surrender fees are as high as 20% imposed on investors who want to cash out before 10 or more years have passed

The Ugly

• Overly aggressive marketing practices
• Commissions to insurance agents so high - that they can tempt the selling agent to act against the buyer's best interest
• Offers of "bonuses" that are not worth as much as they seem and that some people never actually collect
• The product can be so complex that it is difficult to tell if the investor is getting a good deal or just getting taken

Even with all the negativity in this article regarding Equity Indexed Annuities there are times when annuities do make sense to have in your portfolio.  My favorite type of annuity is an Immediate Fixed Annuity.  These annuities are fairly straightforward and are usually purchased with a lump sum of money.  In exchange for the lump sum of money the insurance company will pay the investor a monthly income for as long as they live.

 Some people think that the new split in Congress may be a blessing for the markets, however historically the S&P 500 Index has risen 11 percent per year when a single party has controlled the White House and both sides of Congress.  It has risen less than 4 percent when different parties have controlled the House and Senate.
 

Hawaii celebrates its third straight year as having the most millionaires per capita.  According to Phoenix Marketing International, 6.93% of Hawaiian households have at least $1 million in invest-able assets.  Hawaii was followed by Maryland (6.79%), New Jersey (6.69%), and Connecticut (6.65%).  It will be interesting to see if NJ stays in the top three with its tax problem spiraling out of control.
 

The Jets versus Patriots isn't the only New York / New England rivalry going on right now.  The competition between the two is also heated in the tech sector as the two complete for capital dollars and internet prestige.  The Big Apple recently jumped over Boston for the first time to become the number 2 city in the Country.  Silicon Valley has a stronghold currently on the number 1 spot.  In the final quarter of 2010 New York tech start-ups struck 50 deals worth $332.8 million while Massachusetts firms only tallied 39 deals worth $219.8 million.
 

Value stocks trumped Growth stocks over the past 10 years.  Value stocks had an annual return of 4.50% versus Growth Stocks who returned 1.42%.  Pundits of each type of investing argue their cause, but one explanation of value stocks coming out on top may be because it is easy for growth investors to make picks that have future growth already priced in the stock.
 

Retirement Plan Contribution Limits Remain Unchanged in 2011.  The contribution limits for the major employer-sponsored retirement plans: 401(k)s, 403(b)s, and 457(b)s will not get an increase.  The limit will remain at $16,500 for those under the age of 50.  Those who are age 50 and older get the benefit of a catch-up contribution of an additional $5,500.