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Index Annuities—Popular but Watch for these Features

Index annuities offer features attractive to many retirees:

·   Guarantee of original deposit

·   Increasing value based on stock market index

In short, you have your cake and eat it too.  But let’s look closer to help you discern good from not so good.

Every index annuity has a “participation rate.”  This is the percentage that you share in an increase in the stock market.  For example, a hypothetical index annuity based on the S&P 500 index with a 50% participation rate would provide a return of 5% if the S&P index rose 10%.  Why would an investor give up half of the return from the market?  Because if the market declines, you do not lose money as your original principal is guaranteed.  So this arrangement is quite attractive for investors seeking to protect their principal in return for a higher interest rate.

But you need to make sure that the annuity has a guaranteed, fixed participation rate for the entire term of the contract.  If the company can lower or raise the rate (they have little incentive to raise it), do you want to take the risk?

The other issue to look out for is “averaging” of the S&P index.  Many index annuities provide a participation rate based on the “average” increase in the S&P 500 index.  This typically means that the S&P 500 index is measured once per month.  These figures are summed and divided by 12 to produce an average closing figure.  The gain for the year is measured based on this averaged figure. My study of 30 years of index annuity returns shows that averaging reduces the investor’s return.  So all else being equal, you would prefer no averaging in your index annuity (past performance is not an indication of future results).

There are other features to consider, including an annual reset feature, deductions or fees, forced annuitization and potential surrender charges.  Like most investments that seem simple on the surface, index annuities have important features that you must understand. Return the enclosed coupon for more information to understand how you could profit from stock market increases while having your original principal protected.

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(Note: If there is no increase in the S&P 500 during the designated term, investor receives only the minimum guaranteed rate minus expenses.  Withdrawals during the vesting period may cause any and all gains not to be realized.  Guarantee is subject to claims paying ability of the insurance company. The S&P 500 is an unmanaged index that cannot be invested in directly.

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