Fixed indexed annuities

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Annuities

An annuity is a long-term retirement strategy that gives stable growth with minimal to no downside risk. In that respect, it would be like putting your money into any vehicle that has a stable % return, like a savings account, CD, or even a whole-life insurance policy. Unlike savings accounts and CD’s, an annuity defers your taxes until you start making withdrawals. Unlike a whole-life insurance policy, all of your premiums go to your cash value as you are not having to pay for the death benefit.

When people are young and have lots of time, they usually prefer to put most of their money directly into the stock and bond market to capitalize on the most growth. The stock market generally goes up, sometimes over 20% in a year. No other investment will ever match the stock market in a good year.

Unfortunately, as we age, we start to realize that an ill-timed market crash could decimate our retirement accounts. Annuities start to be a good addition to our portfolio. Once money is put into an annuity, it goes up with the market, but it does not decline if the market goes down. We all remember the dot.com crash of 2000, the housing crisis crash of 2008, and most recently the Covid-19 crash of 2020. The graph below shows how this looked from 1998 through 2016:

The red line shows what would have happened to a $100,000 investment in the market as measured by the S&P 500 over time. Your accounts would be getting 100% of the gains in the market when the market is rising and getting the full brunt of declines. At the end of 2016, your account would have been up 106% in 18 years. The olive line shows the same investment put into an annuity that had a floor of zero, meaning your investment account never went down, but a 15% cap. That means if the market goes up more than 15%, your account only gets 15%. In the end, you would have had a 123% gain in your account.

But, the most important thing is to notice what would have happened had you been wanting to be able to use your money in 2000 or 2008. You would have seen noticeable declines in your account value.

There are three types of annuities: Fixed, Fixed Index, and Variable. At Your Insurance Professors, we do not have variable annuities in our portfolio of available products.

Fixed vs Fixed Index Annuities

A fixed annuity is similar to a savings account or CD. It has a guaranteed fixed interest rate that is usually tied to the prevailing interest rates. It might be a little more than you could get just putting your money in a CD.

A fixed-Index annuity is our specialty. These annuities take good advantage of market increases without being susceptible to market downturns. There are many ways these can be structured, and we have many products and different allocations to choose from.

How do Annuities Work?

Annuities have two phases – the “pay in” phase and the “withdrawal phase.” This is true of any annuity type. Paying in can be done in two ways. The most common is the “lump sum” method. You buy an annuity by giving the company a set amount of money. Usually the minimum for this is $10,000. Once you do that, you cannot add any more money to it, although you could always buy another the next time you wanted to invest more. Another type of annuity would let you make periodic payments during the pay in phase.

The pay out phase can also be handled in different ways. It could be an immediate annuity. This means that you could roll some money from your IRA into an annuity and immediately begin to receive payments on a monthly or yearly basis. The other way is called a deferred annuity. In this case, you put your money in and have to wait a certain number of years to take it out.

There are rules with each annuity about how much money you have to put in, what age you have to be, and how long you have to wait to take it out. Any annuity should be considered a long-term project because once you put it in, there are rules about when and how much you can take out.

There are two main variations in how money is paid out. In one case, the most common, you receive a payment for life. This is a life annuity, and this is how you make sure you do not outlive your money. With a life annuity, even if you live to be 120 and the money in your account went to zero, the company would continue to pay you the contracted amount until you die. Another way is a set term annuity. With this type of pay out, the contract would specify that you would receive X dollars per month for 10 years, 20 years, or whatever the contracted amount was.

Annuities can also be set up to pay out for both you and your spouse. For example, if you set up your annuity to cover both of you, and you died, it would continue to pay your surviving spouse until (s)he also passed away.

Annuities can also be set up that provide a death benefit. This is often done in the same way as a return of premium insurance policy. In this case, you receive the annuity payments per the contract, but once you die, your beneficiary receives all of the money you put into the annuity initially as a death benefit.

Upside Potential

We all know there is no free lunch. The insurance company that issues the annuity cannot give you both unlimited upside while protecting you from downside risks. Thus, the upside potential in any annuity is controlled in some way. In the case of a fixed annuity, it is by simply guaranteeing a positive % gain, just like a savings account. Maybe it is 1-2%. No matter what the market does, you would get that increase but never more.

With fixed indexed annuities, the two most common methods are caps and participation rates. We have funds that use both.
A cap rate means that if the market goes up 20%, and you have a 9% cap rate, then your account goes up 9%. If the market goes up only 8%, then yours also goes up 8%.

A participation rate means your fund gets a certain % of the increase in the market. For example, if one of the funds in your annuity had a 50% participation rate and the market went up 22%, your account would go up 11%. If it went up 30%, yours would go up 15%.

Depending on your risk tolerance, you would choose the funds that make up the annuity partially based on what you thought the market was going to do, and how much time you have.

Fees vs No Fees

Some annuities have fees and others do not. The ones we offer give you the choice. Why would you choose to pay a fee? The reason is that you pay a fee to buy yourself a better cap rate or participation rate. For example, the no fee participation rate might be 50%, as described above. That means you will always capture 50% of the market increases and never have any account decrease even in the biggest stock crash. However, maybe there is a version that charges a 1.75% fee, but with that fee you now get a 100% participation rate. So, in the same scenario where the market goes up 22%, you would get the 22% increase instead of the 11%. That 1.75% fee would seem like a great deal.

Of course, there is a downside to this. What happens when the market goes down or is flat? Well, your investment account does not go down as your floor is zero, but the fee is still subtracted from your account, so you would see your account value decrease by 1.75% every year that the market is zero or negative. If you were planning to keep your money in the account for many years, you would make more money with this fee structure. Of course, you would be hating life in 2007-2009, or any year with market decreases, as you would see your account value drop.

Your Insurance Professors can help you navigate this and the many variables associated with annuities and your retirement plans.