Straight Talk on Fixed Index Annuities
Few products generate as much confusion and controversy as fixed index annuities, both pro and con. We’re often asked if these products are any good.
Want the Straight Talk? Money managers dislike fixed index annuities because they lose management assets and many insurance agents simply don’t do a good enough job of explaining how the product really works. This is precisely why opinions about fixed index annuities are so polarizing. But that’s just what they are, opinions. Straight talk is based in fact and cannot be disproven!
Fixed Index Annuities Summarized:
Fixed index annuities are nothing more than fixed annuities with a different means of crediting interest to the account. Fundamentally, fixed index annuities link the appreciation rate of the annuity account balance to a stock market index. In addition, the principle balance is guaranteed so you can essentially make but never lose money. In return for guaranteed protection, the potential growth only works out to a portion of the overall index gain. The basics are simple but a few moving parts gum up the works and that’s where opponents attack.
Critics will call fixed index annuities a raw deal because policy owners are not given full market appreciation and dividends are not included in the interest crediting. If that were true it would seem that insurance companies are stealing gains from the consumer. Such a short-sighted analysis only shows that the claimant understands little of how index annuities work.
You see, because the assets are not directly invested in the market index, no one receives full appreciation and dividends, not even the insurance company. Assets are actually placed in the company’s general account consisting mostly of investment grade corporate bonds and further backed by large reserves that each company is required to hold. It’s a simple risk/reward calculation. If you want principle guarantees, don’t expect the same returns as you’d get in the open market.
Another common misperception is that all index annuities have long surrender schedules approaching 15 years. In reality, surrender terms for most index annuity contracts are no different than those of variable and fixed annuities, ranging from three to ten years. Before anyone criticizes any surrender period they should first acknowledge the basis for such restrictions. If an insurance company has to buy a long-term bond to back any specific product, the company will incur a loss if the contract is cancelled early due to selling bonds or other investment instruments under less than favorable conditions.
Truthfully, fixed index annuities have a solid value proposition in comparison to other investments, no matter the risk factor involved. I too was a major skeptic at first until I took the time to understand the product. Compared to other investment strategies like futures, derivatives, hedge funds and options, fixed index annuities are not at all complicated.
Now to what really matters… are fixed index annuities a good place to put money? All else matters little if the product can offer decent returns. It just so happens that in 2009 the Wharton Financial Institutions Center for Personal Finance completed a study comparing actual index annuities contracts to alternative portfolios of stocks and bonds. Click here to see what they found. The study showed that index annuities were able to produce respectable returns when the market was strong and limited losses during market downturns. Isn’t that exactly what they are supposed to do?
There are a few specific things that every consumer must understand before purchasing a fixed index annuity. Several of the pages on this site dig into the particulars so be sure to poke around and arm yourself with all the information you can before you call.
Most importantly, there are a couple of valuable reports available with a free subscription to Annuity Straight Talk. The Fixed Index Annuity Report is the most complete resource for understanding how the fixed index annuities work, and the GLWB Report talks about guaranteed lifetime income riders that can be attached to various fixed index annuities for additional retirement income options.