Today’s annuities are so complex, it’s safe to say most people who’ve been sold one have little understanding of how they work. To help, let’s cover some general and specific features of both indexed and variable annuities, the types sold about 80% of the time.
During the accumulation phase, before you start to draw out money, variable annuities basically allow you to invest in mutual funds that rise and fall with the markets.
With an indexed annuity, your return is very loosely linked to a chosen stock market index. When stocks rise, you often receive just a small portion of the gain. In exchange, when the market drops, you don’t lose.
In essence, indexed annuities equip investors with training wheels along with knee, elbow, wrist pads and a helmet. All that protection can leave little to be desired. Often, indexed annuities give you only a small return, even in a good year for the market. While you might not lose, there simply isn’t much upside offered.
Becoming an educated investor in indexed and variable annuities requires you to decipher terms like, participation rate, cap, spread, crediting rate method, step-up feature, premium bonus, roll-up period, accumulation value, protected benefit base, living benefits, contingent deferred sales charge and guaranteed minimum rate, among many others. It’s like learning a whole new language.
Within many annuities, insurance companies also offer add-on insurance features that provide protections, at a cost, sometimes significant. These riders are designed to sweeten the annuity for the income phase, but they do require you to keep the product for a set number of years.
The most popular riders available for variable and indexed annuities are generally referred to as, living benefits. They often go by names that include the word, guaranteed. Put simply, among your normal annuity account balance, living benefit riders present you with a steadier “phantom” account balance that you cannot tap into unless you are willing to accept installment payments. These riders frankly make you feel a bit schizophrenic as you must follow multiple alternative account balances – both real and phantom – at the same moment.
Despite the sheer complexity of today’s annuities – whether you already own one or you don’t – gaining a working knowledge is a wise move. Based on the fact that about $250 billion of these annuities were sold last year, there are a lot of sales pitches to handle.
To learn more about annuities, join Jason P. Tank, CFA on Wednesday, September 14th at 6:30pm for his presentation for the Front Street Foundation’s Money Series held in the McGuire Room at the Traverse Area District Library. Front Street Foundation is a nonprofit with a commitment to provide open-access to financial education, for all. Visit FrontStreetFoundation.org.