BUNK 16
EQUITY-INDEXED ANNUITIES—BETTER THAN NORMAL ANNUITIES
If you’re skipping around in this book and haven’t read Bunk 15 yet on variable annuities, go there first, then here. This bunk builds on the other bunk like a bunk bed. Annuity firms know annuities are a tough sale (that’s why they pay such big commissions to salespeople!) and folks are figuring out they get lousy growth plus huge fees. So they created a relatively new product—equity-indexed annuities—sold frequently as having more upside potential than a standard variable annuity. Fair enough, but is it true? There are two basic ways these are sold.

The First Pitch

Growth is guaranteed at a minimum rate (like 6 percent) and investors get full upside participation in the stock market. Who doesn’t want a guaranteed return floor and full upside?

The Catch

The drawback comes from the confusing nature of linking insurance and investments. (Never forget: An annuity is, first and foremost, an insurance contract.) Normally, with these annuities, it’s the income base growth that’s guaranteed, not the actual account value—which fluctuates up and down with the market like any other investment, albeit usually with much higher fees. The income base doesn’t really apply unless you decide to surrender ownership of the account in return for regular distributions based on the income base size.
The problem is, many investors who buy these annuities don’t intend to surrender the account and take income. They may buy them thinking they’re a “safer” alternative to a mutual fund—and yet, the growth guarantee may not apply to the part of the annuity they care about! You must read and understand the convoluted annuity contract. It’s hard. They’re confusing.

The Second Pitch

Participate in the stock market’s upside with no downside risk! Investors are often promised 75 percent to 100 percent of the upside and none of the downside. Guaranteed income base growth may be offered as well.

The Catch

These types of annuities usually have capped returns (hidden in the details), which can substantially lower long-term performance relative to the market.
For example, an annuity promising 100 percent index participation, a 3 percent minimum return guarantee, and a 10 percent annual return cap may sound great. After all, stock market returns have averaged about 10 percent a year over long periods, so you’re not giving up much, right? No—remember Bunk 5. Average returns aren’t normal. Stock returns are up big and down big more often by far than up middling amounts—the insurance firms know that. After all, they’re in business to make money—and they make sure the contracts are solidly in their favor. And there’s nothing wrong with insurance firms making money! It’s better for the world and society in general if more firms are profitable than not. But don’t think insurance firms are giving away returns out of the goodness of their hearts. To them, it’s a business transaction—one they design to be profitable to them.
Table 16.1 shows $1 million invested in the S&P 500 for 30 years (through yearend 2009) compared to the same invested in a hypothetical annuity with 100 percent upside capped at 10 percent and a guaranteed annual 3 percent return (similar to many equity-indexed annuities). That 10 percent return cap seriously impaired return, lowering annualized returns from 11.2 percent for the S&P 500 over that period to 7.6 percent1—which hurt, big time—a difference of over $15 million.
Table 16.1 S&P 500 Versus a Hypothetical Equity-Indexed Annuity—Upside Is Usually Capped
018
Another tactic some (very wretched—which is most of them) annuities use is tying performance to an index that doesn’t include dividends, which can make a huge difference over time. For example, from 1926 until 2009, the S&P 500’s annualized return with dividends reinvested in the index was 9.7 percent. Without dividends, it was just 5.5 percent.2 Why not include the dividends? That’s a normal part of investor total return—just not for many annuity owners.
So why would anyone own one of these? No idea. I’ve never been able to figure it out. Some folks say they get benefits, like life insurance on the side. Ok, but there are a million better ways to skin that cat—like buying actual life insurance! Term life insurance is exceedingly cheap. When you mix objectives, like “growth, capital preservation, and life insurance,” you tend to get an expensive mish-mosh that doesn’t really satisfy any of those objectives well.
I could go on and on about the perils of annuities, but won’t, because this shouldn’t be a 500-page book. Remember this: Read the contract, super closely. Also consider, for all the fees you pay, what the odds are of getting much better results much cheaper elsewhere. (Hint: It’s high.)
..................Content has been hidden....................

You can't read the all page of ebook, please click here login for view all page.
Reset
44.210.151.5