Are Indexed Annuities a good Investment?
As is the common theme of many of the topics of discussion on our companies fabled blog, indexed annuities are financial products that are widely misunderstood and seldom used, that is unless you have planned with a advisor. It is because of this that I choose to shine the light on this shadowy corner of the financial industry.
Lets begin with a accurate definition. Indexed annuities are fully insured financial vehicles. They aim to provide security for portions of an estate that are desired to be sheltered from the risk of loss associated with open market transactions. More often than not money earmarked to fund retirement (IRA’s,pensions,401k’s, 403b’s etc.) or where principal protection is vital, are natural suitors for such an investment. The balance of a soon to retire employee’s well funded retirement plan is typically considered vital to maintain. In this situation, the lack of time and working days available to accrue and compound interest on funds that need to serve as a replacement for losses confirms this importance.
So how do indexed annuities address this need? First, and most critically, the contributions paid into annuities are fully guaranteed. In short, there is no risk of losing any of the money contributed. The financial companies that issue annuities are legally contracted to return these contributions and they all happily do, with interest. It is the interest crediting method that provides this unique feature. No part of your indexed annuity balance is ever placed in any sort of variable security, stock, bond or mutual fund. Thereby eliminating the risk of any losses associated with being invested in such assets. Instead, as the name implies, your interest will mirror the major indices of the market (S&P 500, Nasdaq 100, etc.). The interest credit available will have some sort of floor rate your account will be given if the index return falls below that minimum and a ceiling that caps how high of a interest return can be credited in that given period. Essentially, you will be giving up the possibility of having very high returns in a booming bull market for the safety of a guaranteed rate of return given in the face of a major bear market.
In exchange for these guarantees you will be giving up liquidity. Very similar to taking out a CD with a bank, a annuity is a promise to relinquish your money to the firm in question for a given period of time. You are heavily incentivized to not touch this money by way of fees, penalties and even bonuses. Unlike a CD, you will surrender this money for a minimum of 6 years, and we have seen maximum periods for as long as 15 years. However, also unlike a CD is the greater potential to actually accrue some real interest. The average return on indexed annuities are between 5% and 8% annually. Where your money falls on this spectrum depends on the length of the contract and the indices it is pegged to. In general, indexed annuities offer about triple the rate of return in comparison to any CD. At the end of your contract you are free to use the money as you see fit. It is actually this end phase of indexed annuities that attract many to this product. A annuity can be planned such that the funds accumulated can be paid out as lump sums or in a variety of structured installments. In many cases such payouts can last for life, even after the balance has been depleted. If your annuity is a qualified retirement plan then this structured payout is crucial to the avoidance of unnecessary tax burdens during the mandatory minimum distribution phase.
The applications of a financial vehicle that offers guaranteed principal protection, moderate interest growth and lifetime payouts, are many. A plan that can be designated as a qualified tax deferred IRA, payable immediately to your beneficiaries (not estate) upon your death, with no management or annual fees should be known by everyone. The amount of common consumers who take advantage of such a plan are to far few in contrast to all the problems it can help solve. The only drawback seems to be the non-liquidity of using one. This is an issue that really is redundant however, considering most savings and qualified retirement plans only accrue with significance in a hands-off environment. The latter even being penalized if not treated as such by the IRS. If you have any sum of money that you wish to park and secure, a indexed annuity is a great alternative to CD’s, stocks or bonds. Send us a message to see how they may help you.
