Annuities-The Perfect Storm
When it comes to income, guarantees are not a luxury; they are a necessity. Social Security is an important source of guaranteed lifetime income. Guaranteed income needs demand guaranteed income products.
A Fixed Indexed Annuity is a principal-protected contract with a minimum guarantee. In fact, “not a single indexed annuity purchaser has lost a penny as a result of the market declines, bank failures, or general weakening of the economy.”
When bubbles burst like the real estate market and stock markets did in 2007, they don’t re-inflate to their previous levels for a long period of 
time — typically 20 years or longer.
Remember that back in October 2007, prior to the most recent market meltdown, the Dow was at 14,000 points.
Today, it’s at 10,000. Consider the Dow, which stood at 7,487 on November 13, 1997, and then was again at 7,486 on March 18, 2009, almost 12 years later.
When the market drops by 50 percent on your $100,000, taking it to $50,000, you need not a 50 percent gain but a 100 percent gain just to break even. Striking an appropriate balance between risk and reward is critical.
A much less-recognized retirement vulnerability is the risk of outliving one’s financial assets due to longevity and fluctuating asset values during retirement..
There are two types of fixed annuities – fixed rate, where the interest rate is declared and paid by the insurance company annually, and fixed index, where the interest earned is based on the performance of a stock market index such as the Standard & Poor’s 500. The fixed index annuity is also known as an equity index annuity.
A fixed index annuity’s interest rate isn’t known until the end of the period being measured, because it’s based on the performance of an index fund. Usually annual, and based upon the initial purchase date of the annuity, if the index increases over the period from what it was at the day the annuity was purchased (or the day after, in some cases), then the annuity earns interest at a rate based on the gain in the value of the index.
If the index loses value, though – and this is crucial to understand – then the fixed index annuity doesn’t lose anything – its value doesn’t decline, but it also doesn’t increase.
While not earning interest over the course of a year, those investors who invested in an actual index fund for the same index – say the S&P 500 – over the same period would actually lose principal. Thus, what the fixed index annuity does is guarantee the benefits of the market without imposing any of its drawbacks.
Savvy investors will already have recognized, though, that this is no hypothetical scenario. At the end of 1999, the S&P 500 was at $1,469.25. It then recorded three straight losses, followed by a string of gains that brought it virtually to a break-even point at the end of 2007. There was another disastrous decline in 2008, though, so that at the end of ten years (12/31/2009), the value of the index was $1,115.10, fully 24.10% below its value on 12/31/1999.
The significance of these figures is this: those who purchased FIAs during most of this period gained, and in most cases their FIAs significantly outperformed not only the market, but all other funds: standard equity portfolios, index funds, mutual funds, even bond funds.
Bond investing has experienced an enormous spike in popularity in recent years, as investors have been spooked towards safety. This trend is disturbingly ironic, as the ever-murkier world of bond derivatives has been an instrumental cause of the economy’s unprecedented collapse in the first place.
While the average investor did not directly pour money into a collateralized debt obligation made up of subprime mortgages, that investor has certainly suffered their consequences.
Moreover, traditionally safer bond strategies have been affected by the malaise. Nowhere has this trend been more evident than in municipal bond investing. While munis have remained a popular destination for the flight to safety, some have experienced a bumpy landing, as described in this Smart Money piece:
Since last July, 201 municipal bond issuers have missed interest payments on some $6 billion worth of bonds, or an average of about one every other day. That’s up from 162 in 2008, and a hefty increase from the 31 that did in all of 2007. Almost 13 percent of municipal bonds currently active are trading at less than their face value, according to Barclays — up from 7 percent before the recession… even if the crisis doesn’t spread, it remains bigger than it has been in decades.
Simply put, when bonds are compared with fixed indexed annuities, the stability argument is a rout in favor of the insurance vehicle. This is borne out by research originally undertaken to demonstrate that FIAs were bad investments over the long term; in fact, the farther back researchers went, the more definitively their hypothesis was refuted!
Index fund investors after ten years were still 25% below their initial investment, while those who’d purchased FIAs had almost doubled their money during the volatile first decade of the 21st century. This is what’s meant by the term “FIAs give you all the advantages of market participation with none of the downside risk!”
For people who are risk-averse, such as those approaching retirement within ten to fifteen years, a fixed-index annuity, whose greatest drawback is the possibility of not earning interest in any particular year, is far preferable to an investment which could lose value, which is what could happen if the money were invested directly in the index fund.
Indexed annuities — particularly those offering principal protection, reasonable rates of return, diverse liquidity options, and various income options — should be considered for every retiree’s portfolio as they prepare for their retirement years.
As with other fixed annuities, the risk is borne by the insurance company, not the investor. And while some may criticize the perceived liquidity restrictions of FIAs, virtually all FIAs today offer 10 percent free withdrawals annually, and shorter contract lengths are common today. Many now offer income options without requiring annuitization.
Annuities are designed to generate a lifelong income when you are no longer drawing an earned income. Increased focus on both increased retirement savings and the importance of a guaranteed lifetime income stream will reduce the retirement vulnerability of retirees in the future.
Once interest is credited to a fixed index annuity, it becomes part of the principal amount on which the next year’s interest payment will be calculated, and cannot under any circumstances be lost. This is called the ratchet and reset principal – the annuity’s value is ratcheted up and then reset at that higher value. By comparison, money invested in a mutual fund or stock index fund, once credited to the principal balance, is just as vulnerable as the rest of the principal.
A fixed index annuity, then, is an insurance product whose principal can never be lost to market fluctuations because it’s not invested in the market. When the index increases in value over the course of a year, the annuity earns interest based on the increase in the index’s value. If the index loses value, the fixed index annuity neither declines nor increases.
A balanced investment plan should include at least one investment that pays a minimum interest rate and offers a guaranteed income as a settlement option. A fixed insurance annuity is an important piece of any retirement portfolio. Annuities are not the only solution to solving retirement problems, but they are just another tool that people may want to keep in their tool kit.
You can purchase an income stream that can be designed to last as long as you want? Would you like your income stream to last for decades, maybe even your lifetime?
Only an insurance annuity can guarantee a payout over an unknown time, such as a person’s lifetime. The payback choice can be changed whenever desired. The 6 choices are:
- Interest-Only paid each month. The principal is conserved for a beneficiary.
- Monthly payments for one person’s lifetime, with or without minimum numbers of payments guaranteed (Single Life Income).
- Monthly payments for two person’s lifetimes (Joint Life Income).
- Monthly payments in a specified amount, until the values are exhausted (Fixed Amount).
- Monthly payments to payout the value in a chosen number of months (Fixed Years).
- Any Method Agreed Upon between the owner and the company.
So as the perfect storm continues to gain strength, with the uncertainty that seems to be surrounding the future of Social Security benefits, the stock market performance, and the increase in life expectancy it’s great to know you can purchase an income stream that may protect you during these uncertain times.
