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5 Facts About Equity-Indexed Annuities

We like and use equity-indexed annuities or as they are sometimes called, fixed-indexed annuities for many reasons. Let me give you a brief description and see if it is something that may appeal to you.

What if you could be indexed to the upside of the stock markets, but not lose money because the stock market plummets, crashes or corrects? What if you had access to 10% of your account balance at all times and the gains of the stock market were locked in for you automatically as the market goes up over the long-term?

Having watched many people go through two massive market declines in 10 years and watching years of savings and contributions get wiped out in the blink of an eye, we were on the lookout for alternatives. That is when we were introduced to the equity-indexed annuity. After being around the sales and service of equity-indexed annuities since 2009 and seeing all the benefits, we are bigger fans now than ever before.

Here are 5 facts about equity-indexed annuities:

Your money is not invested in the market. Let me say that again. Your money is not invested in the stock market. That is a good thing. This is what allows the insurance company to offer you principal protection on your money. Think of it like a CD at a bank. That money is invested in the general fund of the bank and they guarantee interest on that money and year in and year out it steps up in growth due to the interest rate.

Equity-indexed annuities work exactly the same way, but the main difference is instead of being tied to interest rates it is tied to equity indexes in the stock market. The insurance company purchases call options on the index it is indexing to you and over the course of a year or two years if that index is above where it was when you started then the insurance companies credit you the gains based on the provisions of the contract. If the stock market goes down, then you just move sideways and your money cannot lose due to stock market losses.

Your principal is guaranteed. Since your money is not invested directly in the stock market the insurance company is able to guarantee the principal of your money. What most people that we meet want is for their money to be able to grow or capture the growth of the upside of the market, but don’t really want to incur the downside. These products allow you to do that with the funds that you invest.

Gains are locked in automatically. If your contract has an annual lock-in or a lock-in every two or three years on that date, the gains are automatically credited and then the principal of your policy is now locked in at that new high. You then start fresh for the next one, two or three-year window. Why would a contract wait beyond one year to lock in gains? Purchasing option contracts on an exchange can be expensive and unpredictable to the insurance company. By purchasing longer-term call options beyond one year, it typically reduces the expense of purchasing options by over 66%. An industry executive said they would prefer to create a contract that only locks in every 5 years because the odds of the market being higher are so much more statistically in your favor and the costs would be reduced dramatically. They balance that with the client experience that is used to getting a statement every quarter. Going five years without locking in gains is too long from a psychological standpoint.

Free withdrawals allow increased liquidity. Detractors to indexed annuities talk about how illiquid they are. Granted, we have to manage liquidity as part of basic financial planning, but let’s talk about that. Industry data shows that over 70% of indexed annuities and all annuities, in general, are sold with qualified retirement dollars. Those funds, if they are IRA funds, are 100% taxable to the individual upon withdrawal. The funds were put away in order to provide for a paycheck after retirement.

Further, with social security providing for the averaged retired couple over 40% of their base income needs we typically don’t see these accounts and certainly the funds inside equity-indexed annuities as their emergency money. It is the paycheck money. With that, equity-indexed annuities for the majority offer 10% free withdrawals annually, without a surrender charge. Meaning if you put $250,000 into an equity-indexed annuity after the first 12 months you could withdraw $25,000 without penalty. You would be paying income tax if that is IRA money. So, there is substantial liquidity available, not to mention it is RMD (Required Minimum Distributions) friendly and there is the potential for guaranteed income riders if the client so chooses.

Fees are not higher than industry averages. Fees for all financial products need to receive more scrutiny now more than ever. The industry average of most managed money, mutual funds or advisory funds is costing investors 2-3% per year and most don’t offer principal protection and locked in gains. Many of the indexed annuities we use are charging between 0-3% in fees depending on the riders, bonuses or death benefits that are selected.

Equity-indexed annuities for our clients have actually been a breath of fresh air because it allows them to stay invested and indexed to the markets without the mental and emotional ride of the downside. As you age and as you want your income to be more predictable having principal protection of your money is powerful, but also having the ability to produce uncapped returns is powerful as well.

All equity-indexed annuities are not created equal and that is why we only use a very small subset of the products available to us in the marketplace because they meet very clear and important criteria. If you want to see if an equity-indexed annuity is right for you, please contact us here.