Investments require a good deal of thought and research. After putting forth time and resources into the investment, an investor would normally expect transparency from that investment.
However, while mutual funds are transparent, equity indexed annuities can lack transparency and be very complicated.
It is difficult to ascertain the yields of equity indexed annuities because they are set by the insurance companies, at their discretion.
The minimum floor level required by the National Association of Insurance Commissioners (NAIC) is 87.5 percent.
This means if an individual invests in an equity indexed annuity, the company must—by law—pay back the same percentage to him/her. Most contracts stipulate that the company will allow the investor to participate at a 90 percent level, with a two to three percent floor.
Each equity indexed annuity product declares a rate in which the investor participates in the growth index, usually the S&P 500.
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Annuities
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Rates range from 50 to 100 percent participation, but investors will never participate in the dividends of the underlying index, and the S&P 500 Index currently has about a two percent yield.
After calculating an investor's share of the index's growth, many of these contracts create an additional adjustment known as the yield-spread cost factor. The annual cost can be reset by the insurance company. It is difficult to understand, and even if an investor knew what the yield-spread factor was, he/she would rarely—if ever—be able to calculate it.
A growth cap is a cap placed on the growth rate of the underlying index. For example, if the bank stipulates that it will give an investor a maximum of one percent per month and the S&P 500 grows five percent per month (as it does occasionally), then the investor will receive one percent rather than the four percent difference. This cap can be reset by the insurance company, so an investor may never be certain of his/her participation level.
Bonus credits entice investors by promising a 10 percent return for investing in a certain product. Investors should read these contracts carefully. In some cases, if the investor forfeits the contract before the full term (usually 10-12 years), then he/she won't receive the bonus at all; or the investor may only be able to get the bonus by leaving the money with the insurance company and annuitizing it. In both of these cases, this means that the investor would have to leave the investment there for a long period time.
In addition, investors should be aware of surrender charges.
Some surrender charges are up to 20 percent and last as long as 10 years. Investors may want to keep this in mind when evaluating equity indexed annuities.
If an investor would like a guaranteed investment product (GIP), he/she should consider purchasing a government guaranteed zero-coupon bond for 10 years. This bond will allow an individual to invest money for 10 years, at which time the bond will still have its full value. The return on the bond is about 3.8 percent, so if you invest $70,000, then it will be worth $100,000 in 10 years.
Another alternative to consider is to invest it in the S&P 500 Index directly. For example, an investor could buy a Vanguard S&P 500 Index Fund and pay no brokerage fee going in and no surrender charge going out. Ten years from now, the investor is probably going to have more money and will get to retain more of it because there is no participation rate, index spread, backside charges, or front side charges.
At this point, the investor will have built his/her own strategy that may work better.
To learn more information, visit annuityadvantage.com.
