The corporate pension plan is an endangered species, and is becoming more and more rare. For many retirees and pre-retirees, annuities have filled the gap left by pension plans. They are part of an overall strategy for guaranteed cash flow to replace or supplement a pension, to protect against inflation, and to protect one spouse in the event that the other passes away. Many investors are now using annuities as a personal and family pension plan.
The best strategies often include several types of annuities used in a scheduled approach. This article will examine one such annuity type that can be used to create a family pension fund – the fixed-indexed annuity.
Overview of Fixed-Indexed Annuities (FIAs)
An FIA is a type of annuity that grows with the return from a specified stock market index (such as the S&P 500®), reduced by certain expenses and formulas. You may also hear FIAs referred to as equity-indexed annuities (this is an old term that FINRA, the regulatory agency, no longer permits), as well as the newer term, hybrid annuities. Some FIAs, and indeed the ones we are interested in here, have lifetime income riders that guaranteed set payments for as long as you and / or your spouse may live.
Two Values in One Contract
A fixed-indexed annuity has two values, much like a variable annuity: a pension-like Income Benefit Base value, and an Actual Value (also referred to as the Accumulation or lump-sum walk-away value). The difference between the two is very important, so let’s look at each in detail.
The Actual Value is, in a nutshell, the amount of money you would walk away with if you surrendered the contract.
Most FIAs have an up-front bonus of 8% to 10% added to your account value when you deposit the initial premium. You can allocate your investment into two allocation options, a guaranteed fixed allocation and an index allocation. The allocation percentages may generally be changed once a year at the contract anniversary. Both the guaranteed fixed percentage and the index choices vary by company. The standard index in the industry is the S&P 500. Rather than an index fund, the actual closing value of the index is recorded and tracked based upon the day the account is funded. Each month, on that day, the index number is recorded and tracked and reconciled at the contract anniversary. The account will not lose value, ever, due to a loss in the index value. The account retains all gains made during the course of that contractual year.
On the vast majority of contracts, there is a monthly sum limit, called a cap, of 2% to 3% (24% to 36% annualized). Another allocation choice is an annual point to point, which presently has a cap of 3.5% to 6.5%. Historically, the return averages between 5% and 7% depending on the index and allocation selected. However, given the present state of the economy, you may or may not see those rates and count on that percentage. There is a minimum interest rate guarantee, which is usually between 1.5% and 2% in the event the index return is flat or negative. As of this writing there are two fixed-indexed contracts in the industry have no cap on gains.
The income benefit base is NOT the same as the account value, and you can’t walk away with this value.
Income Benefit Base Value
The second important value to understand is the Income Benefit Base Value. Rather, it is an insurance value that establishes the value by which your income is determined when and if you take income from the annuity. Let’s take a look at the Income Benefit Base Value in more detail.
In addition to a typical 8% to 10% up-front bonus, during the income deferral period an annual interest rate (also called a “roll-up”) of between 5% to 8% is added and compounded to the income benefit base. It additionally insures that if the growth of the actual or accumulation value is lower than the roll-up (5% to 8%), your income benefit base grows by that guaranteed roll-up. If and when you choose to take it, the guaranteed annual income of an FIA with a lifetime income rider can be determined to the penny. It is based upon your age and the time between when the deposit is made and the income begins. The income is not annuitization. You still maintain 100% access to your deposited money, and may withdraw more or less. However, you must wait at least 12 months before the first withdrawal on the vast majority of the contracts. In contrast, the vast majority of variable annuities stop the guaranteed income benefit base growth based upon the roll-up or step up when any withdrawals are made.
Contractual Differences Among Fixed-Indexed Annuities
The following factors need to be considered when choosing an FIA:
Depending on the insurance company and the product, the annual fee ranges from 0.50% to 1.70% (average of 0.95%). These fees do not reduce the income, but rather are deducted from the actual deposited value. As of this writing, we know of one FIA that has no fee; however, it only has 4% compounding each year on the income benefit base roll-up, as opposed to the industry standard of 5% to 8%.
Withdrawal Rate Factor
The withdrawal rate factor is based upon the youngest attained age at the time income commences, and the withdrawal rate or percentage of the income benefit base, which ultimately determines the income payout when income starts.
Check each FIA contract to see whether or not a one-time or systematic withdrawal from the contract would stop the roll-up (contractually guaranteed annual increase of the income benefit base).
Spousal continuance is not lifetime income for the non-owner spouse, although many companies imply misleadingly that to be the case.
Non-owner Spouse Benefit
Check each FIA contract to see whether or not the contract benefits are the same for both the owner and the non-owner spouse (especially on qualified money such as a 401k, IRA, or 403b). One may elect a single lifetime or a joint lifetime income even years after issue. Please be aware of the term “spousal continuance,” which is a feature pertaining to the income value in some contracts.
Included in every FIA contract is a feature that states that your beneficiary (or beneficiaries) will receive any remaining balance in the event you die prematurely. Some annuities offer enhanced death benefits, which have a guaranteed increase each year and pass along the income benefit base to your beneficiaries. Many people use an FIA for the death benefit provision, especially if they have no plans to access withdrawals, since the bonus is 10% and the compounding interest rate is at a minimum 4% plus all gains each year. It functions in a similar way to a fixed annuity and there is no underwriting.
Home Health Care Benefits
A few companies issuing FIAs offer a benefit that doubles your contractually based income payout in the event that you need home health care or enter a nursing facility. This benefit pays the annuity owner and allows the flexibility to choose the caregiver. One company even offers a benefit that triples the contractually based income payout.
Finding the Right Fixed-Indexed Annuity
Many fixed-indexed annuities sound similar, if not identical. However, contract language determines the practical use of the income benefit and any other benefits promised by the colorful brochures, and will make one contract fit your situation more than another. Our experience in teaching people about the various fixed-indexed contracts will help you to select the right one and avoid the wrong one. All facts we state can be confirmed by printed brochures and will appear in the contract language. We often even like, with a client on the phone, to place a call to each annuity issuing insurance company and verify the details.
For more information and to help you find the best fixed-indexed annuity for your needs, contact Annuity FYI at 1-866-223-2121.
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