Index Annuities Explained on One Page
Lots of people tend to overthink big financial decisions. It happens all the time with annuities. When you’ve heard constantly from other sources that annuities are complicated then your search is started with a negative opinion, grounded in nothing but someone else’s opinion. You’ve probably owned mutual funds before but I doubt that many of you have read the entire prospectus. Talk about boring and complicated!
In reality an index annuity is not that hard to understand. It may seem so because too many agents speak only in sales pitches. That leaves you wondering how all those wonderful promises are possible and many of you decide it’s just too good to be true.
Well that’s not the case. You just need someone to simplify the product so you understand first and foremost how it works. For years I’ve been talking about how the important components of a contract can be listed on one page. After a recent meeting with a man who was overthinking the issue I decided it might be helpful if I wrote it all down on one page so he didn’t spend too much time thinking about irrelevant technicalities.
So here it is: Index annuities explained on one page. Start with the basics so you have workable knowledge that can be used for more important issues like creating a retirement income plan.
Start with Fixed Annuity:
- Insurance company invests premium in bonds
- Receives +/- 4.5% and takes a spread or portion of the yield to cover expenses and produce profits
- Roughly 3% remaining is credited to annuity as guaranteed yield
**estimate only and actual rates depend on bond maturity and length of annuity surrender schedule
Fixed Index Annuity is Slightly Different:
- Contract can be credited with 3% fixed rate, or…
- The fixed interest will be used to buy an option in an external market index
- If index is positive, earnings from the option are credited to annuity as earnings
- If index is negative, interest earnings are lost
- Principal is never at risk so the contract will not lose money
Index Options and Crediting:
- Each contract has several options for external indices and money can be divided among all available options at buyer’s discretion
- Interest is credited once annually at which point you can change how the money is allocated to the available market indices, the fixed rate account or any desired combination
- Any earnings are locked in as principal and will never be subject to loss going forward
- Fixed interest earnings do not buy 100% of the market option so cap, participation and spread rates determine how much of the market index yield is credited to the contract
- Limitations aside there is excellent growth potential available with yields into double digits likely, although 5% is a reasonable expectation for long-term yield
- Standard 10% of account value available for withdrawal annually without penalty
- Sometimes lower free withdrawal can be exchanged for higher growth potential
- Fees only apply for benefits additional to the above, such as…
- Enhanced earnings potential with higher cap, participation or spread rates
- Guaranteed lifetime income, long-term care or enhanced death benefits
It does not need to get any more complicated than this. Obviously certain components above can use more detail but you need the basics first. Start here and build upon that as you investigate ways to use the contract in your portfolio. Certain sales strategies might cause you to lose focus of what’s important. It’s kind of like buying a car based on the color alone.
If someone is trying to sell you a contract and you can’t figure out how the promise relates to the basic structure then you are not getting the service you deserve. I’m here to help so feel free to call, email or make an appointment.
Last Updated on February 1, 2023 by Bryan Anderson