Pros, Cons Of Indexed Annuities
June 2, 2015 by PAUL KATZEFF, INVESTOR'S BUSINESS DAILY
Indexed annuities are hot. In a survey by Wink’s Sales & Market Report — a researcher serving the life insurance and annuities industries — annuity carriers reported first-quarter sales of $11.3 billion for these kissing cousins of traditional variable annuities.
That was up nearly 5% vs. the same period last year. It was the best Q1 in the history of indexed annuities, according to [Wink].
“Imagine what record sales levels will be achieved in 2015, with a start this strong!” the site quoted Sheryl Moore, president and CEO of Wink.
So, are indexed annuities something you should consider as part of your retirement planning?
That depends on whether you need their benefits enough to justify their drawbacks.
Start by understanding how they work. An indexed annuity is built around a bundle of investments that you choose. The investments are based on an index like the S&P 500. Any earnings on the investments are tax-deferred.
The annuity is basically a contract from an insurance company, which pledges a return based on the index’s performance during a specified period, such as a month, year or longer. If the S&P 500 gains, say, 10% yearly, your annuity return is likely to be much lower.
Fidelity Investments found that in rolling 10-year periods from 1926 to 2013, a typical indexed annuity returned about 3% annually. An index comparable to the S&P 500 averaged 10% annually, says Morningstar Inc.
“An indexed annuity is attractive to people who are sensitive to volatility,” said Valerie Chaille, president of SummitView Financial in Indianapolis.
Top Five Sellers
As of Q1, the top five indexed annuity sellers were Allianz Life, American Equity Companies, Security Benefit Life, Great American Insurance Group and Athene USA, according to LookToWink. Fidelity sells variable annuities, but not indexed annuities.
Why not invest in the index itself, either directly or via a mutual fund or ETF, and get the full return minus only any expenses? Because the contract also promises not to subtract anything from your principle if the index falls during the investment period.
And some contracts pay you a guaranteed lifetime income.
In addition, a traditional variable annuity typically holds mutual-fund-like bundles of securities called subaccounts. You may have to choose among up to 100 or more. An indexed annuity offers investors a choice among only about half a dozen index funds. “Your choice is much simpler,” Chaille said.
Sounds sweet. But there are potential drawbacks.
The gap between the index’s return and the return to your account can be big, Fidelity Investments warns. Many contracts allow the insurer to reduce its return calculation during the investment period.
And return formulas typically exclude dividend income, Fidelity says.
Modest Returns
Indexed annuities often offer certain bonus payments to customers. Still, overall returns tend to be modest. “The return on indexed annuities is typically comparable to a conservative investment product’s return, and not to the stock market, a stock market index, or stock fund returns,” Fidelity.com says.
Also, indexed annuities generally do not have an upfront sales charge. But, as with many VAs, you often pay a big fee if you withdraw money before the surrender period ends.
Wink’s Note: Insurers do not have a choice in excluding dividends from the calculations on indexed annuities; as this is determined by the options seller. Indexed annuity purchasers do not directly invest in the index, and as a result, no benefits of the dividends could even be received. The index is simply a benchmark; not an investment.
Indexed annuities are priced to return 1-2% greater interest than fixed annuities being sold on the same day. Today’s average fixed annuity credited rate is 2.55%. That means indexed annuities issued today will likely return 3.55% – 4.55% over the life of the contract.