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Fixed Indexed Annuities
Fixed indexed annuity industry wide sales
amounted to $30.1 billion in 2009. (1) Eighty percent
of boomers want lower volitility and will accept lower
returns vs. an investment that puts their money at
risk. (2)
What is
a
fixed indexed annuity?
A traditional fixed annuity is based on a fixed
interest rate. The fixed interest rate is declared at
the time the annuity is issued and then reset each
anniversary of the annuity by the insurer and the new
delared rate runs until the next anniversary and so
on. However, some contracts can be locked in regarding
the interest rate for time spans such as five
years.
The fixed indexed annuity is the same as the
traditional fixed annuity except other options are
available regarding measuring returns. That is, within
a fixed indexed annuity the fixed interest rate option
still exists however the return can also be based on
the changes in specific indexes such as the Standard
and Poors 500 index (S&P 500 index) or other
indexes such as the Nasdaq or Financial Times index
(FTSE). Many insurers allow you to pick and chose
amounts allocated to the several indexes offered as
well as allocations to the fixed interest rate
option.
Capped
returns and zero return floor
The change in a particular index can be measured
by several different methods and over varying time
periods. Regardless of the method or time period
chosen a "cap" will be set at the time of issue and on
each subsequent anniversary. The "cap" is the maximum
credited change in the index. For instance, the cap
might be set at 7%. Hence if the change in the index
is +11% the maximum you would be credited is 7%. If
the change in the index is 5% you would receive the 5%
as it does not exceed the 7% cap in this
example.
A zero return floor also exists. The zero
return floor is protection against a decline in an
index. Basically if an index as measured has a
negative change, say -10%, then the zero floor kicks
in and your return becomes zero (0%). Hence any down
side risk is negated by the zero floor. Of course as
mentioned above, up side gains are
capped.
The zero floor means principle can not erode
while the annuity is deferred/accumulation
status.
Do fixed
indexed annuities have long surrender charge
schedules? Do you have access to the principle?
At the advent of fixed index annuities circa 1995
the surrender schedules were ten years and longer.
Today the schedules vary but can be as short as 5
years. Moreover, today there are multiple accesses to
the value of the annuity that do not require surrender
or surrender charges. Penalty free withdrawal
provisions (10% per year) are common, as well as
loans, and full accumulation value at death not
subject to surrender change is common.
Do sign
on
bonus exist?
Sign on bonus do exist although not available from all insurers and not available on all contracts. The bonus is generally 5 to 10% of the initial deposit. However, some contracts make the bonus available for as many as the first five contract years meaning any deposits received during the first five contract years qualify for the bonus percentage.
Bonuses generally become part of the principle
amount and are then subject to the zero floor meaning
principle can not erode.
What is
ratcheting?
Ratcheting is the procedure of locking in
return
and the value of the return becoming part of the
principle and subject to the zero floor. That is,
returns become part of principle and can not erode.
For example, the particular return method and
particular length of time the contract specifies for
the measurement occurs and your return for example is
6%. The 6% return is then added to principle and the
6% return now being part of principle can not
erode.
Ratcheting is in essence a reset. That is, if
external indexes create a -10% return the zero floor
kicks in and the return is set at 0%. Furthermore the
negative index return one year does not need made up
as the return for the particular year is set at zero
percent. Hence you are not faced with having a return
in a subsequent year in excess of 10% to make up for
the -10% performance. The ratcheting means the
particular anniversary measurement date is set anew
and performance for the next anniversary measurement
period is not dependent of a prior measurement
period.
Can
annuities be non-qualified as well as qualified?
Annuities can be tax deferred annuities in the
non-qualified world. For example, you transfer money
from a certificate of deposit to an annuity. The money
then accumulates tax deferred (no current tax applied
to the gains while the annuity is in tax deferred
status).
Annuities can also fund tax qualified
items such as IRA, IRA rollovers, simplified employee
pension plans and super IRA's.
Can you add rider or enhancements to a fixed indexed annuity?
Riders and enhancements are available. Some
insurers offer long term care riders and income
accumulation riders that compound the principle at a
specified interest rate. Other enhancements are
available depending upon the insurer.
Do you
have
to annuitize the product to receive the benefits?
No. Annuitization is merely one avenue of
receiving benefits. Fixed indexed annuities offer
multiple ways of accessing the values without
annuitization. Annuitization is an option as well as
lump sum access and life time withdrawal streams that
are not annuitization streams.
Summary
Fixed indexed annuities are insurance
contracts
that offer tax deferral, a death benefit, and
retirement income with returns based on external
market indexes without directly participating in the
market. No erosion of principle/preservation of
principle is the hallmark feature.
As with any financial product one needs to
consult their own financial advisor regarding
suitability.
Notes
(1) The Allianz Reclaiming the Future Study
Executive Summary, Allianz Life Insurance Company of
North America, 2010, page 3.