Where Fixed Indexed Annuities Fit In Retirement Planning
Fixed indexed annuities are one of the top selling insurance products available today
. Fixed indexed annuities offer a minimum interest rate (typically between 1% and 3%), while also having the potential to participate in a portion of the markets upside growth.
Annuities are typically seen as a safe way to earn a fixed return on your money while deferring the taxes on your gains. Fixed annuities offer a specified, but in exchange for that guarantee, typically you will receive a lower rate of return. Variable annuities let you place your funds in any number of investment-grade securities and, therefore, offer better returns, but also risk losing money.
During the previous bull market security-based annuities became so popular that insurance product developers were drawn to the concept of combining the security of a guaranteed return with the allure of participating in the booming stock market. Voila: Equity-indexed annuities!
Fixed indexed annuities offer consumers what could be described as the best of both worlds: a market-driven investment with potentially attractive returns, plus a guaranteed minimum return. Brokers and agents like EIAs for another quite practical reason: because EIA returns are tied to indexes of market activity and not to the performance of individual stocks or funds, they have not been considered an investment product subject to U.S. Securities and Exchange Commission oversight. Therefore, while variable annuity products must be registered with the SEC, must issue prospectuses and can only be sold by professionals with securities licenses, Equity Indexed Annuities are not federally regulated and brokers don't need a securities license to sell them.
But just what are equity-indexed annuities? And are they really the best thing since sliced bread? Any why do some financial experts call them the worst of both worlds?
"They're all different"
Just understanding the equity-indexed annuities market is a daunting task. "If you've seen one equity-indexed annuity, you've seen one," an actuary said recently. "They're all different."
Equity-indexed annuities guarantee customers a minimum interest rate (often about 3 percent) while offering the potential of higher rates by tying your return to an index like the Standard and Poor's 500.
While it's a lot like investing directly in the stock market, customers don't get the full boost of a rising market. With equity-indexed annuities, the money put down by purchasers isn't invested directly in the stock market. Instead, customers are offered a percentage of how much the index gains over a period of time (not including dividends, which accounted for about 30 percent of the total return of the S&P 500 for the last 20 years), and a guaranteed minimum return if the stock market declines.
At predetermined times during the annuity's life, customers are credited with a percentage of the gain of the index. The schedule varies with each annuity. Some offer annual "indexing," while others use various averages taken over the life of the annuity.
The percentage of the index's gain that a customer receives is called the "participation rate." These rates vary all over the board, with some companies offering 50 percent and others offering 100 percent or more -- but you have to read the fine print.
For example, a product offered by Physicians Life has a 100 percent participation rate, but it's not based directly on the S&P 500. Instead, customers receive 100 percent of the average of the daily closing prices during the course of a year.
At the end of 1994, the S&P 500 was at 459. When 1995 came to a close, it had risen to 616 -- a pretty hefty 34 percent gain. The average of the daily closing prices during 1995 was 542, a gain of just 18 percent. Therefore, you'd get 18 percent. That's not bad, but if you'd invested in the market yourself, you could have had that 34 percent gain. (It should be noted that mutual funds also have administrative costs, so your actual return would be less than 34 percent.)
Most equity-indexed annuities offer participation rates between 70 and 90 percent, and some place a cap on how much you can gain. If the product has a 14 percent cap, and the market gains 34 percent, you're stuck with 14 percent.
Say you plunk down $5,000 (a typical sum) for an equity-indexed annuity with an 80 percent participation rate and a 14 percent cap. If the S&P 500 goes up 15 percent, you'll gain $600. If you'd invested your $5,000 directly in the stock market, you'd have gained $750.
Many happy returns?
While it would seem investing in the stock market might be a better option, it's also riskier. Equity-indexed annuities are designed to offer a safety net -- that guaranteed minimum return.
Most companies offer a guaranteed minimum return of at least 3 percent, but sometimes that's not on the entire sum you put down. More often, the company guarantees you'll get at least 3 percent of 90 percent of your deposit. If the stock market takes a dive, you could still lose money.
Even if the guaranteed return is based on your entire deposit, you might just wind up breaking even. Over the last few years, inflation has averaged about 3 percent. If you earned 3 percent each year on a deposit of $5,000, you'll have $6,149.37 after seven years (a typical term for an annuity). But if inflation keeps steady at 3 percent in those same seven years, your $6,149.37 will be worth the same as the $5,000 you put down in the first place.
Equity-indexed annuities are not currently regulated by the federal Securities and Exchange Commission. But that could change. The SEC is seeking comment on whether the products should be categorized as insurance, a security or both.
Insurance companies cover their costs for equity-indexed annuities by investing the premiums they collect. Companies typically buy coupon bonds to cover the guaranteed minimum return, and call options to cover market appreciation. It's a delicate balance -- one which doesn't offer the company any guarantee it'll make any money. Companies often use interest-rate caps to cover their bases.
How good an investment are equity-indexed annuities? If you had bought one just before the collapse of the stock market instead of investing in the stock market itself, you would be very happy right now!
Before you invest in an Equity Indexed Annuity you will want to read the fine print. There are surrender charges for early withdraw, although most companies now allow yearly withdrawals at set amounts. Notably, the surrender charges often decrease the longer you let the company keep your money.
by: David T. Wilson
When You Are A Victim Of Identity Theft - You Are In For A Crime And You Need A Lawyer Ways To Get Your Retirement Money Early Without Penalties Learning How To Fish In Retirement Paradigm Life-saving For Retirement Now How Can Rancho Cucamonga Ca Lawyer Benefit You? Gastric Bypass Malpractice Lawyers Of Chicago Investing In Bullion Important Things To Consider When Going For A Retirement Or Pension Annuity How To Select The Best Pension Annuity And Enjoy Your Retirement? Domestic Violence Lawyers Enjoy The Best Phase Of Retirement In A Retirement Facility Show Your Appreciation With These Retirement Gift Ideas Why The Demand For Houston Criminal Lawyers Increasing Rapidly