 | John Eck
is the owner of the ECK Agency, Inc., which is an independent insurance agency representing over 80 companies offering life, health, property & casualty insurance. Beginning his career in 1968, he is a Certified Insurance Counselor, a licensed Kansas insurance broker, and has held numerous positions with other related business ventures. Currently an active member of his local School Board, he has also held elected positions on the City Council and Hospital Board in past years. John can be reached at his office by phone at (800) 444-4911, or you may e-mail him at: eck@eckagency.com |
Insurance
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About annuities
Q: I recently retired. I have the opportunity to roll out of a qualified retirement plan from the company I worked for and into something else. Considering all, an annuity makes the most sense for me. I visited with several firms about whether to go with an index or a guaranteed fixed annuity. I received conflicting answers. Can you give me some facts on both?
A: I will try. First, let me provide a little information on annuities.
An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals, under which you make a lump-sum payment or series of payments. In return, the insurer agrees to make periodic payments to you beginning immediately or at some future date. (In reality however, most annuities today are not much more than a substitute for an individual’s savings that could be placed in either a bank, credit union or insurance company providing the annuity).
Annuities typically offer tax-deferred growth of earnings and includes a death benefit that will pay your beneficiary a specified minimum amount which is generally the amount of the annuity premium paid plus interest earned to the date of death. While tax is deferred on earnings growth, when withdrawals are taken from the annuity, gains are taxed at ordinary income rates. If you withdraw your money early from an annuity, you may pay substantial surrender charges to the insurance company, as well as tax penalties (if taken prior to age 60).
There are generally three types of annuities — fixed, indexed and variable. In a fixed annuity, the insurance company agrees to pay you a specified rate of interest during the time that your account is growing. The insurance company also agrees that the annuitized periodic payments will be a specified amount per dollar in your account, if annuitization is elected. These periodic payments may last for a definite period, such as 20-years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.
In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance, assuming that you leave the money with the company for a specified number of years.
In a variable annuity, you can choose to invest your purchase payments from among a range of different investment options, typically a mutual fund type of investment. The rate of return on your purchase payments, and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected. Since you did not mention you were considering a variable annuity, and because how they work is totally different from index and fixed annuities, I will not address them in this article. Here are some discussion points of both.
Guarantees: The only guarantee in most index annuities is that you will at least get your principal back. This of course would be a loss, a significant loss, when compared to a one to three percent lifetime guarantee of a fixed annuity.
Caps: The caps that index annuities have in place limit considerably the upside potential. When analyzing one of the best performing index annuities recently over a 10-year period of the hottest market ever in history, I found that it outperformed a fixed annuity with the same company by approximately 1% over the entire 10-year period. Once most people understand the risk/reward quotient, seldom does it make sense for the significant exposure to a zero rate of return that is inherent in the index products.
Fees/Liquidity: Index annuities are more costly internally. The fees involved in the purchase of options in the market (the way in which index annuities realize their growth) are quite a bit higher than any fixed annuity. Often to actually use the money, the annuitant has to annuitize the contract which gives the annuitant no liquidity at all.
Timing: Timing is everything when investing in index annuities. Two identical amounts going in a day apart on two different accounts can change the per cent return substantially. This is possibly because the index beginning period is the date the company receives the money so if the market index differs a day or week later, it will affect the total interest credited.
Suitability: I have found that most people, when explained the intricacies of index annuities, are not suitable. Suitability requires (among other things) sufficient assets to overcome any loss; a thorough understanding of the complexities of the product; experience in investing in that particular type of product; a time horizon that will allow for some recovery when zero rate returns occur.
If there was enough reward in the current list of index annuities, I could see an experienced investor, with a 10 to 20 year time to invest the moneys, with no liquidity needs, put a portion of available investment assets (money that can lost without causing hardship) into a good index annuity. With today’s caps however, such reward is not there. The majority of people do not understand the complexity of the product and the risk involved in them. Even though most folks might say they have money they can afford to lose…they really don’t. Quite often, investing in the “turtle” beats the “hare”. When a person has moneys in savings and has it earmarked for retirement, he/she would do best to put the most emphasis on the ‘sleep well factor’ rather than listening to a salesperson talking about the inflation fact, which always involves risk.
