Understanding Index Annuities...

One of the top selling financial products of 2022 is the often misunderstood “Fixed Index Annuity” . Also known as an “Equity Index Annuity” because the returns are linked to the stock market . Per an article dated October 26, 2022, on CNBC.com, Equity Index Annuity sales hit a record $80 billion on Q3, 2022, slightly beating the prior record from Q2, 2022 which was $79.4 billion. Read this article here.

While these annuities may be a desirable choice for some savers, they are often sold by unscrupulous salespeople. Many of them use aggressive tactics and often leverage client’s fears to make a sale. For more on this, check out these supporting articles; Index Annuity Scams and New Name, Same Scam. In a 2018 article, Forbes Magazine went as far as calling the Equity Indexed Annuity a Ponzi Scheme. You can read the full article here.

Warren Buffett once said, “If you don’t understand the company, don’t invest in it.” We believe that the same goes for annuities. If you are approached by an index annuity salesperson, below are some things you should understand before you invest. Also, remember that if it sounds too good to be true, it probably is.

Questions to ask:

Equity Index Annuities often have returns tied to a stock or bond market index. However, your gains are limited by one of several crediting options including annual point to point, two-year point to point, monthly sum, etc. In addition, you must understand the participation rate, spread, or cap. Sound complicated? It is. If you plan to buy one of these products, make sure you understand these details completely. This is important because Equity Index Annuities contain a lengthy surrender charge (covered in our next bullet point) that protects the insurer from loss.

Most index annuities have a surrender period of 7-10 years, but we have seen some that last up to 15 years. This surrender charge is a big deal. If you are not happy with this investment after, say, 2 years, well, you’re stuck until the surrender period is over. Further, 10 years is an exceptionally long time. Your life and need to access your money can change drastically over 10 years. Further, the amount of the surrender charge can be large, typically, in the neighborhood of 10% - 20% of the full contract value.

Since annuities have a long-lasting surrender charge, they counter this with a free withdrawal. This is usually between 5% and 10% of the contract value, of which you can withdraw with no surrender charge. Anything over the free withdrawal is subject to the surrender charge.

To entice people into buying an index annuity, insurers will offer a bonus to investors. The bonus amount is often between 5% and 20% of the contract value. So, if you invest $100,000 into an annuity with a 10% bonus, you start with $110,000. It is important for you to understand that this bonus is not a gift, it is prepaid interest that is subject to a vesting schedule. This is important for two reasons:

1. If you surrender the annuity policy during the surrender period, you also forfeit some of the bonus.

2. You are being paid interest in advance. Therefore, the crediting option (used to determine your annual return) in a bonus annuity is less than the return in the same annuity without the bonus.

We have seen commissions as high as 10%. We believe this creates a conflict of interest for the salesperson. If you invest $100,000 into an annuity, they can earn up to $10,000 to close that sale. It may be difficult for the salesperson to keep the client's needs first when they have a large payday influencing them.

This blog only covers the tip of the iceberg of Equity Indexed Annuities, but the main point here is that you are dealing with your hard-earned next egg. Due to long surrender charges, the penalty for not being informed can be huge and impact the returns on this type of investment for 10 years or more.

If you need additional information, feel free to contact our team at CWM. We have helped clients navigate the trials of learning what they are being asked to buy and how to deal with pushy salespeople.