Annuities Are Like A Rose

Last year’s market meltdown was a stark reminder of how vulnerable individuals’ investment portfolios can be. There is no such thing as a safe investment in the stock market. People are not saving anywhere near enough to have a great retirement. A lot of baby boomers have no savings at all for retirement. The average savings for retirement is something like $50,000.

Quoting Ben Stein; It would be awful to live a penurious, miserable, horrible, boring existence while you’re young, but it would be even worse to be starving or in desperation or unable to sleep when you’re old.  We need to provide adequately for the fact that we’re probably going to live 20 years after we retire.

A rose is a beautiful flower; however, no one just reaches in and grabs it.  We all know that the stem on a rose plant has thorns.  At first glance these thorns represent a negative, undesirable feature.  However, the thorns are there to protect the flower.  The thorns provide strength to the stem protecting against high winds and/or animals.

The thorns on annuities work the same way by protecting your investment. An annuity is an investment vehicle that is marketed by insurance companies, and it is based on a pooled resource risk providing strength and stability to your investment. I call it a “Rose Annuity” because it meets the strict insurance department requirements for interest guarantees and guarantees against loss of principal, and it provides traditional annuity benefits.

If you want to be guaranteed an income for life, annuities feature a regular payout that is not affected by market fluctuation’s, an (Rose) annuity is a financial product that pays a person a guaranteed income for a period of time or for a lifetime. Folks who are worried that a market crash could wipe them out, an annuity provides stability and safety they can sleep comfortably with.

What Are Equity Index Annuities?

There is a new class of annuity that provides a portion of market index performance with a no-loss provision. It is known as the equity index annuity. This new type of annuity is not a security, as you might suspect, but it is classified as a single-premium traditional annuity.  Equity index annuities typically offer other benefits that are not generally included in traditional policies: a 100 percent money-back guarantee, no front-end sales charges, and no annual management fees.

Let’s look at what makes this such an attractive savings option.

No-Loss Provision
The first and possibly most-attractive provision of equity index annuities is the no-loss provision. This means that once a premium payment has been made or interest has been credited to the account, the account value will never decrease below that amount. This provides safety against the volatility of the market index to which the annuity is linked. They actually provide you with the benefit of investing in the stock market without the associated risks of losing your money. So, in an equity index annuity, your principal is never lost and even in a worst case you may take some interest back home.

Interest Guarantees
The next benefit that appeals to many people is interest guarantees. Most policies have a cap (the maximum interest rate that can be credited to a policy in a policy year) and a floor (the minimum interest rate that can be credited in a policy year). The cap rate can vary from no cap to a fixed percentage, but the floor is generally 2 to 3%. This allows the policyholder to benefit from potentially high returns and be guaranteed at the same time that no money will be lost.

Competitive Rates of Return
With concerns over inflation and making sure that investments will meet our future needs, many people have turned to the equity market for higher returns. It makes sense when you consider how well the S&P 500 index has performed historically.

Many times EIAs are not properly compared to a pure equity investment because they are a fixed-income product with lower inherent risk and, in most investment periods, a lower return.  However, Using a the  (Source: Morningstar Principia) If you had invested $470,000 over a recent period, here is a comparison of what you would have had by investing in a major fund: Vanguard Index 500: $933,216  Your Equity Indexed Annuity (EIA): $940,000. 

As you can see, the EIA would have beaten the pure equity index over one of the worst investment periods in history.

Traditional Annuity Benefits  (Rose Thorns)
Equity index annuities offer the same benefits as traditional annuities. Notable among these are tax-deferred growth and early withdrawal of funds without penalty. This early withdrawal is usually conditioned upon the annuitant’s death or admittance to a nursing home.

An Equity Indexed Annuity with an Income Rider is a contract between you and the insurance company which provides:

 1) Guaranteed return of principal,

2) Returns linked to an index (subject to a cap),

3) Credited gains cannot be lost,

4) Guaranteed minimum interest,

5) Liquidity features (nursing home, critical illness & 10% annual withdrawal),

6) Taxes not due until withdrawal,

7) Avoidance of Probate,

8) Protection from creditors,

9) No annual fees (other than the cost of the rider depending on the carrier) and

10) guaranteed income you (or you and your spouse) cannot outlive.

A “Rose Thorn” is most annuities have surrender charges which are assessed in the early years of the contract if the owner surrenders it before the company has had the opportunity to recover its costs of providing you with a safety net throughout the term of the annuity. Additionally, the earnings portion of withdrawals are taxable as ordinary income and, if made prior to age 59 are subject to a 10 percent federal tax penalty.

The equity index annuities, as in any kind of investments, have to be kept untouched for a long period. The typical time is a minimum of 7 years. However, this will ensure that you get the full benefit of having invested in an equity index annuity.

Of course, EIAs are not appropriate for every investor. Participation rates are set and limited by the insurance company. So an 80 percent participation rate means that only 80 percent of the gain experienced by the index for that year would be credited to the contract holder.

Also, like most annuity contracts, EIAs have certain rules, restrictions, and expenses. Some insurance companies reserve the right to change participation rates, cap rates, the spread/asset/margin fees or other fees either annually or at the start of each contract term.

These types of changes could affect the investment return. It is prudent to review how the contract handles these issues before deciding whether to invest.

Guarantees are provided by the issuing insurance company.  Equity index annuity values fluctuate with changes in market conditions. The performance of any index is not indicative of the performance of any particular investment. Individuals cannot invest directly in any index. Past performance is no guarantee of future results.

A fixed indexed annuity with an income rider can effectively cover a specific income gap in a client’s retirement income stream more efficiently than a diversified portfolio. This is because even a diversified portfolio can fluctuate in value while a fixed annuity is insured against that. Even at 5 percent – widely considered as a safe withdrawal rate on a well-diversified portfolio –  a unpredictable market movement can dramatically affect its performance.

Annuity income riders, like the thorny stem on a rose, are designed to provide safety of investment, predictable, guaranteed, lifetime income and peace of mind to people who are worried about running out of money in retirement.