This paper is an introduction to Fixed and Fixed Equity Indexed Annuity Contracts. It is not prepared as a product endorsement of any one contract or insurance company. When considering annuities it is important to understand the details of the contract being offered. Part of every investment consideration is how the particular investment fits into your overall plan. This paper will outline some of the basic features of funding fixed and fixed indexed annuities but for a full understanding you will need to meet with an advisor. Once the advisor understands your unique financial circumstances a specific recommendation can then be made.
Some Questions to consider
What is most important to you when you look at your retirement accounts?
- Is it Growth?
- Life time income?
- Guaranteed principal protection?
- Tax Deferred or Tax Free appreciation ?
These investments are: fixed and fixed equity indexed annuities. An annuity is simply, a savings account with an insurance company. An annuity can be funded with either qualified money (pretax dollars) or non qualified money (after tax dollars). When considering an annuity one needs to understand the various components that make up this saving vehicle.
Guaranteed Surrender Account Value
Think of an annuity as if you were putting your money into two or three buckets. Each bucket is filled with the same dollars, but each treated differently by the insurance company.
The first bucket is: the Guaranteed Surrender Value Account (GSV).
This account is guaranteed by the insurance company at a fixed interest rate. Basically no matter how the other buckets perform, this account at the contracts’ inception has guaranteed value each year for the length of the contract.
Current Account Value
The second bucket is: the current account value (CV).
This bucket can either have a fixed interest rate for a predetermined period of time, example: five years.
It might also have an index crediting method to a cap. The caps are adjusted annually by the insurance company depending on market conditions.
I like to keep the index crediting method simple. One simple method is an annual point to point credit based on one of the market indexes like the S&P 500, Dow Jones Industrial Average or a Bond index.
When this method is employed the money in the bucket is tied to a market index and not invested directly in the market.
There are many types of index crediting methods. Your time horizon and sophistication will determine your comfort level with each method. Typically your advisor will choose the best method based on the current market. Each year you may change the method of crediting on your contract. So it is important to have an annual review with your advisor prior to changing strategies.
All annuities have a surrender charge as a percentage of current account value (CV) that declines each year depending on the length of the contract.
Surrender charges are actually a positive aspect to annuity contracts. The surrender charge allows the insurance company to make long term investments and prevents contract holders from making a “run on the bank” that would put other contract holders at risk. Typically the surrender charge is in force for the entire term of the contract allowing you to walk away without penalty or roll the contract into another annuity at the end of the term.
Life Time Income Riders
This is an optional third bucket where your initial funds are can be used to calculate a guaranteed life time income benefit (LTIB).
This account is completely separate from your Current Value Account and is only used to potentially calculate a life time income benefit.
All annuities can be annuitized and guarantee income for life. The LTIB rider is different from annuitization because it is not a return of principal and interest but based on a guaranteed value at inception.
You can choose a rider to be added to your contract, typically there is a nominal cost for the rider and in some cases no cost at all. Every contract is different but the riders all work in the same manner.
Depending on the term of the contract the insurance company might offer a bonus on money invested into the contract. Today these bonuses range from 5% to 10% with some bonuses paid later as a loyalty reward.
If the bonus is paid day one then $100,000 would create a CV account of $110,000 day one; also if you have the LTIB rider that account would also receive the bonus. Both the CV and the LTIB account will receive future interest credits based on $110,000. This is very popular because of the recent losses experienced in the market.
This is an introduction to some of the factors to consider within annuity contracts and is not meant to be an exhaustive explanation. If you are considering placing some of your money into an annuity contract you should fully understand the guarantees of the contract and the riders you are purchasing. Annuities are a great way to get tax deferred growth on your money; avoid probate while enjoying contractual guarantees. Many annuities also have other benefits: Nursing home / terminal illness waivers of surrender charges as well as no surrender charge on the death of the contract holder. Most modern annuity contracts are highly liquid as well. In most cases 10% may be withdrawn each year without surrender charges.
There are penalties from the IRS if one makes a withdrawal prior to age 59 ½ of 10% plus ordinary income tax on any earnings. The financial professional who offers this product must ensure it is suitable for your circumstances.
I am available to review all this information in detail and am looking forward to hearing from you.
Call me at: 978-927-1121
Eric S. Erickson, RFC®