Fixed Index Annuities are complicated in their calculations but inherently they are quite simple contracts. Before we can dive into the pros and cons of fixed index annuities, I can’t stress enough the importance of expert advice when making significant asset allocation decisions.
Let us help you with personal assistance explaining how these products work, illustrate what specific value they hold for you, and help you decide if they are right for your situation.
With a reasonable explanation, it’s easy to understand the pros and cons of fixed index annuities for conservative asset management, and then make an informed decision if it’s right for you. And indeed, there are many positive components of these products.
Bur first, some housekeeping:
Both Fixed Index Annuities and Equity Indexed Annuities refer to the same product.
It is confusing for advisors and clients alike, so don’t feel bad! The correct term, however, is Fixed Index Annuity as this is squarely an insurance product, and not a security. The term ‘Equity Index Annuity‘ has been used for years to describe these annuities, but that term infers an equity investment like a stock or bond, and therefore a security offering.
In reality, the Fixed index Annuity derives its increase in value from a stock market index, but does not directly hold stocks. Therefore, it’s not a securities offering and is regulated by Insurance industry rules, not the SEC. While there is a push to regulate these annuities as securities, this has not happened….yet.
Here’ the $.10 summary:
1) Fixed index annuities offer principal guarantees with potential growth tied to a major stock market index.
2) You’ll get your money back in the worst-case scenario and you may profit nicely if things go well.
3) When coupled with lifetime income riders, Fixed Index Annuities offer reasonable profitability, excellent safety, decent flexibility, and lifetime guarantees.
Pros and Cons Of Fixed Index Annuities: Pros
Principle and Growth Guarantee- Your initial investment is secure and guaranteed to grow at a low rate. The contract will state the minimum amount you can expect to receive at the end of the surrender period.
Tax Deferral- Like all annuities, your money grows on a tax-deferred basis.
Account Step Ups- In most cases, a new base contract value can be locked in when the index performs well. This gives you the benefit of locking in a new guaranteed basis when the market works the way we all want it to.
Pros and Cons of Fixed Index Annuities: Cons
Capitalization Rates– All contracts state the maximum amount of interest that will be credited to the account. This can be calculated in a variety of ways such as on a monthly or annual basis. With an annual cap rate of 9%, the market index may return 20% but the account will only be credited with the maximum cap of 9%.
Participation Rates– All contract also stipulate the percentage of the index gain that will be credited to the account. This will range from 60%-100%. If the index gains 10% and the contract has a 60% participation rate, the account will be credited with 6% interest. This is also subject to the Cap Rate where applicable.
Long Surrender Periods- These contracts often have very long surrender periods. One reason for this is the fact that you have a better chance for favorable index performance over a longer period of time. Even so, if you have a time horizon of more than 10 years, the principal guarantee may not be as important. Let me state for the record that I have yet to see a good equity indexed annuity with a long surrender period. For instance, one of my favorite products in this category has a five-year surrender period. If you happen to really like it after five years, then buy it again and make it a ten-year strategy. If it doesn’t work that well then you’re money is free a lot sooner.
Crediting Methods– This determines how the index return is credited to your account balance and can have a dramatic effect on the performance of the annuity. Two common methods used are monthly averaging and point-to-point. The averaging method will credit the monthly index average to the account. The point-to-point method will compare the starting and ending values of the index, on a monthly or annual basis, to determine the total return to the annuity account. Also, for additional fees, a high-water mark feature can be added to point-to-point option so you can look back over the period and take the highest value for crediting purposes. All crediting method options are subject to participation and cap rates. This is a very basic approach to the complexities of fixed index annuities.
Fixed Index Annuities: Summary
Visit the Fixed Index Annuity category of posts on this website for a more in depth look at this product type. Over several years we have watched, analyzed, and sold these annuities and have come to understand them quite well.
However, the real analysis begins when you are presented with an individual contract. That’s why The Annuity Report is essential reading and is available for download with a free membership to the site. With the report you’ll be learn all you need to steer around the aggressive sales tactics. Simply sign up in the box below.
If you seek a qualified adviser well versed in the pros and cons of fixed index annuities, please do not hesitate to contact us.