Equity Indexed Annuities
Equity Indexed Annuities
Ever since I came across this board, I have tried to spread the knowledge I gain here to my friends and family. Stock market is often a discussion at our social gatherings. One of my senior relatives told me that she only invests in Annuities as that's the safest. I asked her what type of annuities does she have. Her response was: Indexed Annuities because they are better than fixed and variable annuities. She went on saying she has indexed annuities from Allianz and it didn't cost her anything and neither are there any annual charges. Her principal is protected and her annuity never goes down in value.
I didn't know what to say. Is this even true? How can there be no cost to annuities and how come its guaranteed and it only goes up? I know in Variable Annuity, your account value could go down even though your income base can increase by 5% or more each year. I thought indexed annuities are the worse of all. Anyone cares to enlighten me?
I didn't know what to say. Is this even true? How can there be no cost to annuities and how come its guaranteed and it only goes up? I know in Variable Annuity, your account value could go down even though your income base can increase by 5% or more each year. I thought indexed annuities are the worse of all. Anyone cares to enlighten me?
Re: Equity Indexed Annuities
Larry Swedroe has a whole chapter on them in his Alternative Investments book. IIRC, there were under the last section (Ugly). Here's an article on the pros and cons: http://whitecoatinvestor.com/pros-and-c ... annuities/
My takeaway from his book and this article is that they are complex and should be avoided.
My takeaway from his book and this article is that they are complex and should be avoided.
Re: Equity Indexed Annuities
I am going to guess somebody did not read every page of their contract. That being said, a variable annuity can guaranty that you won't lose any principle. You can do the same thing with your own portfolio by opening up a "collar". You buy a put to protect yourself from the downside of a market. You pay for that collar by selling a call. Plus, normally, some dividend income as well. On the downside this does limit your upside.joshdamon wrote: How can there be no cost to annuities and how come its guaranteed and it only goes up? I know in Variable Annuity, your account value could go down even though your income base can increase by 5% or more each year. I thought indexed annuities are the worse of all. Anyone cares to enlighten me?
Variable annuities are not the worst. They are a choice for the risk adverse. Now, the way they are sold – that is a different question.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Equity Indexed Annuities
But are Indexed Annuities better than Variable Annuities?
Re: Equity Indexed Annuities
Let me start by saying I don't know much about these investments, but here is what I think:
Indexed Annuities are based on stock indexes, like the S&P 500. They guarantee no losses but severely limit the upside. You get the return of the index (no dividends) up to a maximum. If it goes down, your account doesn't.
Variable Annuities have sub-accounts where you put your money. It is like mutual funds inside an annuity.
While I don't know about your relative's plan, there is likely a "load" taken off every payment and an annual fee for management. In my experience, when someone says their investment has no fees, it is because what they pay is called something other than a fee. Let's say that every time you send in a payment, there is a service "charge." It isn't a "fee," but it still reduces your pile. Not getting dividends isn't a fee, either.
Indexed Annuities are based on stock indexes, like the S&P 500. They guarantee no losses but severely limit the upside. You get the return of the index (no dividends) up to a maximum. If it goes down, your account doesn't.
Variable Annuities have sub-accounts where you put your money. It is like mutual funds inside an annuity.
While I don't know about your relative's plan, there is likely a "load" taken off every payment and an annual fee for management. In my experience, when someone says their investment has no fees, it is because what they pay is called something other than a fee. Let's say that every time you send in a payment, there is a service "charge." It isn't a "fee," but it still reduces your pile. Not getting dividends isn't a fee, either.
No matter how long the hill, if you keep pedaling you'll eventually get up to the top.
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Re: Equity Indexed Annuities
I've attended a few rubber chicken dinners where the main course was variations on an indexed annuity (different IA's are built on different indexes).joshdamon wrote:<snip...> She went on saying she has indexed annuities from Allianz and it didn't cost her anything and neither are there any annual charges. Her principal is protected and her annuity never goes down in value.
I didn't know what to say. Is this even true? How can there be no cost to annuities and how come its guaranteed and it only goes up? I know in Variable Annuity, your account value could go down even though your income base can increase by 5% or more each year. I thought indexed annuities are the worse of all. Anyone cares to enlighten me?
The main takeaway is while your downside risk is limited (yes, you will not lose money) your upside gains are also limited. If you're lucky to be invested in the S&P500 index that gains 12% in a year, your "interest paid" (they do not refer to it as a gain) may only be half of that, with the rest used for their profit and further downside insurance for the future.
Most folks in the audience struck me (based upon their questions) as being risk adverse and not looking at the long term view of the equity market. However, they were interested in a product that would provide them better returns than a passbook/CD. While I'm willing to take a bet and suffer a few years (here and there) of losses, my/our overall gains over 3+ decades certainly outpaced such products.
- Ron
Re: Equity Indexed Annuities
Here is the Wiki page on this subject.
http://www.bogleheads.org/wiki/Equity-indexed_annuity
This is one of the times when it is probably just better to keep your mouth shut unless your senior relative actually just asks for advice. Good luck!
http://www.bogleheads.org/wiki/Equity-indexed_annuity
This is one of the times when it is probably just better to keep your mouth shut unless your senior relative actually just asks for advice. Good luck!
Link to Asking Portfolio Questions
Re: Equity Indexed Annuities
Indexed Annuities are a type of Variable Annuity. A insurance company could offer a large cap variable annuity. Or they could offer a "index" variable annuity that tracks the S&P 500. Same difference as a large cap fund and a large cap index fund.joshdamon wrote:But are Indexed Annuities better than Variable Annuities?
If you are on Bogleheads we can assume that the index is better, but it is only better because it tracks a index. Not because of any difference in the insurance contract.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Re: Equity Indexed Annuities
On the surface, these kinds of annuities sound great. No downside risk. Guaranteed minimum growth rate. "No fees". Many others...
How can this be? First of all, there definitely is "downside risk". Try surrendering your EIA within a couple of years and you will find that you will have a pretty big loss because of the surrender charges. The guaranteed growth rate is usually not applied against your full premium. You pay $100k, but your initial guaranteed growth "base" is something less, like $90k. It is the "base" that has the guaranteed growth rate applied to it, which is something like 1-2%. In some products, it could take many years for your guaranteed "base" to actually equal your initial premium. Fees? The fees are hidden, much like an a traditional fixed accumulation annuity. The annuity company is making their money on investing your premiums. Sometimes there are explicit charge liquidations from these kinds of annuities, but many are structured to appear as if there really are no ongoing charges. In a strict sense of the word, that may be true, but if the majority of the gain you experience is consumed by the annuity company, that certainly is "charge" or "fee" in any meaningful way. Don't forget that the index the product is tied to is the index value itself, so all dividends on shares held in the index will be kept by the annuity company. In the short term, the annuity company really is in a position of risk. They will only make money in the long run with these kinds of annuities, so that is why the surrender charges on EIAs can be some of the worst in the industry. They have to structure the surrender charges so that you have an incentive to keep the annuity 10+ years. But by that point, you would have been better off investing in the market anyway.
Is it possible for an EIA to outperform a comparable market investment over a ten year period? You bet. If you experienced a market that had one good year, then two bad years, then one good year, then two bad years, etc. The overall market trend would be down over a ten year period, but would still have some short bull markets during the decline. The EIA would experience a "ratchet" effect while not losing money, and your market investment would almost certainly have a loss. When have we seen such a market in reality? Rarely.
How can this be? First of all, there definitely is "downside risk". Try surrendering your EIA within a couple of years and you will find that you will have a pretty big loss because of the surrender charges. The guaranteed growth rate is usually not applied against your full premium. You pay $100k, but your initial guaranteed growth "base" is something less, like $90k. It is the "base" that has the guaranteed growth rate applied to it, which is something like 1-2%. In some products, it could take many years for your guaranteed "base" to actually equal your initial premium. Fees? The fees are hidden, much like an a traditional fixed accumulation annuity. The annuity company is making their money on investing your premiums. Sometimes there are explicit charge liquidations from these kinds of annuities, but many are structured to appear as if there really are no ongoing charges. In a strict sense of the word, that may be true, but if the majority of the gain you experience is consumed by the annuity company, that certainly is "charge" or "fee" in any meaningful way. Don't forget that the index the product is tied to is the index value itself, so all dividends on shares held in the index will be kept by the annuity company. In the short term, the annuity company really is in a position of risk. They will only make money in the long run with these kinds of annuities, so that is why the surrender charges on EIAs can be some of the worst in the industry. They have to structure the surrender charges so that you have an incentive to keep the annuity 10+ years. But by that point, you would have been better off investing in the market anyway.
Is it possible for an EIA to outperform a comparable market investment over a ten year period? You bet. If you experienced a market that had one good year, then two bad years, then one good year, then two bad years, etc. The overall market trend would be down over a ten year period, but would still have some short bull markets during the decline. The EIA would experience a "ratchet" effect while not losing money, and your market investment would almost certainly have a loss. When have we seen such a market in reality? Rarely.
Even a stopped clock is right twice a day.
Re: Equity Indexed Annuities
The first thing you should do is tell them they did indeed purchase a fixed annuity. It is labeled as such. Its just a new type of fixed annuity. In a nutshell, the company takes your money and invests almost all of it in their general accounts like 95% which is primarily bonds (they take 100% of the amount for a regular fixed and invest in their general account minus fees/commissions etc of course). Lets just pretend though there are no fees for a second. Well then the 5% return (made up number but about what they used to get from their bonds) on this allows the company to guarantee no loss since (and this is finger tip math and not exact), the general account will bring you back to 100%. They then take the 5% and purchase options. If the options do well then they credit you according to the index. If not then you get nothing but didn't lose money.
These are labeled fixed annuities bc they behave like other fixed annuities. They may do slightly better or slightly worse over the long haul. Almost all of the investment piece is the same. And by the way there are fees/charges/commissions associated with the product. They aren't doing it for free. You just aren't entitled to the information. They are not required to disclose it. Agents will typically pretend the insurance company pays them and that you handing over money for this product isn't involved with that for some reason.
They can also unilateral change the caps and participation rates at their leisure. There are also surrender charges.
You also don't get to tax loss harvest. You don't get dividends. You don't get a step up basis at death. Gains are taxed as income instead of the better long term capital gains rates.
Glad they are happy but hopefully now you realize why few of us here would purchase them.
These are labeled fixed annuities bc they behave like other fixed annuities. They may do slightly better or slightly worse over the long haul. Almost all of the investment piece is the same. And by the way there are fees/charges/commissions associated with the product. They aren't doing it for free. You just aren't entitled to the information. They are not required to disclose it. Agents will typically pretend the insurance company pays them and that you handing over money for this product isn't involved with that for some reason.
They can also unilateral change the caps and participation rates at their leisure. There are also surrender charges.
You also don't get to tax loss harvest. You don't get dividends. You don't get a step up basis at death. Gains are taxed as income instead of the better long term capital gains rates.
Glad they are happy but hopefully now you realize why few of us here would purchase them.
Re: Equity Indexed Annuities
No actually they are a fixed annuity. Variable annuities (without some other rider or shadow account) can lose money.alex_686 wrote:Indexed Annuities are a type of Variable Annuity. A insurance company could offer a large cap variable annuity. Or they could offer a "index" variable annuity that tracks the S&P 500. Same difference as a large cap fund and a large cap index fund.joshdamon wrote:But are Indexed Annuities better than Variable Annuities?
If you are on Bogleheads we can assume that the index is better, but it is only better because it tracks a index. Not because of any difference in the insurance contract.
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Re: Equity Indexed Annuities
This will not be the first time you have this experience. The more people you talk to about finances the more you will realize that most people are doing it in a less than ideal way. Adequate for their needs? Many times, yes. But not ideal.
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Re: Equity Indexed Annuities
Yes it is possible.
Yes there are no fees. In the same way, there are no fees to buy an apple. The seller's profit margin is built-in.
One of the previous posts described how you can do this yourself. Another simple way is to construct a t-bond portfolio and use the interest to buy index call options. That's how the insurance company does it. I think you can see why your return would be significantly worse than the market when it does well, and you would never lose money.
Yes there are no fees. In the same way, there are no fees to buy an apple. The seller's profit margin is built-in.
One of the previous posts described how you can do this yourself. Another simple way is to construct a t-bond portfolio and use the interest to buy index call options. That's how the insurance company does it. I think you can see why your return would be significantly worse than the market when it does well, and you would never lose money.