Low Rates Spark Interest in Indexed Annuities

photo_3026_20070825With no real sign of an increase in interest rates, investors continue to look for places to put their money that promise both safety and reasonable returns. Retirees who thought the rate boost was on the horizon have been waiting to earn more on their certificates of deposit and money market funds for quite some time now, with little to show for it. Fed up, people are looking into other options, mainly insurance products, that offer both attractive returns and principal protection. According to a recent CNBC article, those products include indexed annuities and indexed universal life insurance.

While both products fit into many portfolios, they are quite complicated, and industry experts warn to do a little research before jumping in head first.

“With indexed annuities and indexed universal life insurance, the marketing pitch is always that you get all of the upside of equities and have guarantees,” stated Larry J. Rybka, CEO of Valmark Securities, out of Akron, Ohio. “It’s really misleading.”

An indexed annuity is an insurance contract, where the money you put in grows on a tax-deferred basis, in relation to the gains of a market index.  In the first two quarters of 2016 alone, more than $30 billion of indexed annuities were sold, according to LIMRA. So they’re pretty popular. But here’s where they get tricky. Because the annuity is not directly invested in the index, you are not “fully exposed to its increases or declines.” In order to keep your account balance from dropping when the index does, insurance companies use derivatives, which are complex financial instruments. On the flip side, any increases to your account are subject to limitations imposed by the insurer. For example, if the index tied to your account goes up by 10%, you might only capture 5% due to these restrictions. This is also referred to as “rate caps,” “participation rates,” and “spreads.” These rates, as well as the interest crediting formula, are at the discretion of the insurance company, and can be changed. Furthermore, annuities are subject to surrender periods, often ranging from 5 to 15 years, depending on your contract. This means you could see some heavy penalties if you try to cash out early.

Despite some of these complexities, indexed annuities can be a great match for many investors. They provide a steady stream of guaranteed income without a ton of risk.

“Adding an indexed annuity to your retirement portfolio makes sense if you have a need for guaranteed income and want to make sure you have your basic expenses covered when you stop working,” said Tom Burns, chief distribution officer for Allianz Life.

But there are some drawbacks as well. Perhaps the biggest is how indexed annuities are marketed: often as an alternative to equities. Additionally, living benefits can be confusing. Here, you pay an extra fee for a growing stream of income that can be used in the future.  The dollar amount of the living benefit is determined by the insurer, but be aware that this isn’t cash you can have right away. Instead, it’s a value that the insurance company will use to figure out how much income you receive. How much monthly income you receive will vary according to the details of the contract, the account value and when you start taking withdrawals. Those are the details you need to discuss with your advisor before purchasing the annuity.

Indexed annuities are undoubtedly attractive amid low interest rates, but because they are difficult to understand, they aren’t necessarily a no-brainer. It is always advised to ask a lot of questions when discussing how any product can fit into your portfolio with your trusted financial advisor.

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