There are many problems with these products, but the biggest is that the caps and participation rates they quote you when you first buy the annuity are typically not guaranteed contractually. In fact, many of the “promises” they make up front are not guaranteed. They may give you a participation rate of 100% initially, but if you read the contract they have the right to lower it at their discretion. So if the markets move in a direction that hurts the insurance company, you may find out that they have the right (contractually) to lower your payout to 50%, or your cap to 3-4%.
I know this to be true first hand as my Dad purchased one. Believe it or not, he was told his participation rate would be 110%. And it was for the first year! But when his anniversary date rolled around he received a letter from the insurance company. You guessed it…they were reducing his participation rate down to 50%, and there was nothing he could do about it because the annuity had a 7 year penalty period if he cashed out early. And can you guess what his participation rate was for the remaining 6 years? You got it…50%. And I’ve heard the same thing from clients of mine who have had these products with caps that started at 10-12% and are now down to 4%. And if you have one that charges a fee, that fee can be raised contractually.
Another problem with these annuities is the length of time you are locked in to the agreement, called a “surrender period.” Most of the ones sold today lock you in for 10 years, meaning if you take your money out early you will pay a penalty. The number one selling EIA in 2011 had a 10 year surrender period and the penalty was 10% for the first 3 years on the contract. I have also seen higher surrender periods and penalties. I met with a client a year ago and her surrender penalty was 17% in the first year with a surrender period of 15 years.
So how do you protect yourself? The easiest way would be to avoid these products altogether, as there are better options for you. If you ARE considering an Equity Indexed Annuity, then make sure you do your homework. Make sure you are getting your advice from the right person, which is probably not the person who is pitching it to you. I recommend getting a second opinion from an advisor who doesn’t earn a commission from the product.
If you have had any experience with an equity indexed annuity (good or bad), please share it with us by leaving a comment below.
Am I kidding you? ABSOLUTELY!
If you have retired recently, or are going to be retiring soon, you have probably been hit up to purchase an Equity Indexed Annuity (EIA). No? Oh, that’s probably because the financial service industry has done a bang up job of marketing. You may not have even been told it’s an annuity. You’ve probably heard how you can get “Stock Market Returns without Risking your principal.” WOW! If that were the case, who wouldn’t do it. The sad truth is, retirees are doing it by the truckloads.
Total 2011 indexed annuity sales set a record at $32.3 billion dollars, capping off a fourth consecutive record year. So why are retirees flocking to these investments while the state insurance departments and the Financial Industry Regulatory Authority (FINRA) has issued warnings about these products (click here to see the FINRA warning)? The answer is simple. Financial salespeople motivated by large commissions and incentives!
Now, before I get a bunch of angry emails from EIA reps…Can an Equity Indexed Annuity ever be a good choice? Possibly, but you probably won’t find it from the rep who is inviting you to a free dinner seminar or giving you a “complimentary consultation.” So, how do you protect yourself? Knowledge! You need to know enough about the product to recognize it when you see it. So keep reading and you will…
An EIA is simply an annuity that links its return, interest rate, payout, annual credit (whatever they may call it) to the return of an associated index…typically the S&P 500. In other words, the return you get on your money will be linked to what the S&P 500 index return is for the year. Sounds simple enough…but the truth is that it is far from simple. These products are extremely complex and the crediting methods are even more. The return you get may be tied to the S&P 500, but it is far from equal to that return. Why? Because the insurance company has to guarantee your principal. Let’s just say they compensate themselves by taking part of your return, charging you a fee or both.
Most plans take part of your return by setting a cap on the return they pass on to you or setting what is called a participation rate. For example, they may set a cap of 8 % meaning you will get whatever the S&P 500 returns for the year up to a maximum of 8%. So, if the S&P returns 6% for the year then you get 6 %. If it returns 15% for the year, you only get 8%. A participation rate is similar but is a percentage of the total return. For example, 90% participation rate would mean you get 90% of whatever the S&P 500 returns for the year.
“So what is the problem?” you may be asking. Join me for Part 2 of this series where I will discuss some of the problems and what you can do to protect yourself.
Things are changing all over the place at Seniormark! We are so excited about these changes, because it means we will be able to provide the same excellent service our clients are used to, while being able to add even more ways of teaching and expanding the knowledge base of our clients.
Today’s exciting announcement is that our website has been completely redesigned and has a fresh new look! We hope you will head over there and take a peek. We will continually update it with new videos, keep our prices current, etc. Bookmark it and visit often for changes!
Please check out the new website at https://www.seniormark.com and let us know what you think!
I recently read an excellent article in AARP Magazine about the inherent conflict of interest that many so called “financial planners” have and what they do to hide it from you. It’s the same thing I have been teaching people about for over 15 years and why I am a “fee only” Certified Financial Planner™.
Definitely worth the time…what you don’t know can hurt you!