What are the negatives of Fixed Index Annuities?

All investment products and strategies have certain pitfalls. Unfortunately Fixed Index annuities have been over stated and improperly recommended creating at times an unsuitable financial planning situation. Financial products are a lot like tools used properly they are fine when used improperly they create irreversible damage. The tools are not at fault but the person using them can be very inept.

**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.

1) Unqualified insurance salesman. Far too often, the people who offer EIAs/FIAs to retirees are inadequately licensed and trained, and sometimes they don’t accurately explain the investment principles and retirement concerns involved.

I should also point out that there are some very competent investment advisers who started out in the insurance industry. They have progressed from that starting point and acquired the necessary education and licensing to understand and offer the current sophisticated investment strategies. Check credentials and experience also do background checks it always costs less in the end to work with a true professional. State laws require annuities to be acquired through a licensed insurance agent or financial planner/educator

2) Over zealous insurance salesmen overstating performance. Fixed index annuities are like any other investment used properly they work great when used in unsuitable ways they can be a disaster.

Unfortunately they are misrepresented often as giving full market returns with . The to principal is true and at times they do equal or beat the market. Unfortunately that is not always true. In a strong economy with stocks doing well it is expected that the Fixed Index annuity will fall several percentage points behind the market return however a FIA with a 5% to 8% interest return and to principal for many retirement plans would be considered a win-win situation.

FIAs are annuity contracts between you and a life insurance company. They are simply a fixed annuity that is linked to the performance of a stock market index, commonly the S&P 500, Dow Industrials or the NASDAQ. An FIA has a **guaranteed minimum rate of return (**guaranteed by the insurance company and not the FDIC), and it gives you the ability to capture a portion of stock market gains with no market losses. That’s the upside. Overall, FIAs are not designed to beat the stock market even though many have from 1999 through 2010. They are basically designed to outperform the fixed markets such as CDs, Money Markets and Bonds.

One downside is that you usually have to hold onto a fixed index annuity for several years to enjoy its full advantage. The term to maturity is typically 8-12 years, and sometimes longer. That money is allocated to that annuity during that time. You can’t just go and pull your money out like you can with a money market or savings account. If you need to pull your money out of an FIA soon after you sign the contract.

1) You may have to pay a surrender charge. It varies from annuity to annuity, but it can be in the vicinity of 9-12% of your principal.

2) Most FIAs allow ten percent annual withdrawals with no penalty

3) You may lose some or all of the index-linked interest that the EIA has already accumulated on the portion you withdraw.

4) You will owe taxes only on the increase in value of the annuity. (Withdrawals by annuity holders younger than age 59.5 are subject to a 10% penalty levied by the IRS.)

It is important to plan properly so the Fixed Index Annuity can be a long term solution for your retirement needs. You may lose money if you need to get out of the FIA soon after you open it this should rarely ever happen with proper planning. However if you keep your money liquid and lose the opportunity to make 6% and only make 4% the extra 2% per year for ten years will actually cost you a lost opportunity penalty of 31% by default. That extra 2% compounded will increase your asset value by 31% so if you plan properly the Fixed Index annuity has the potential to make a significant difference over fixed income investments, cash equivalents and at times it actually does have the potential to exceed stock market returns!

Fixed Index Annuity Pitfalls:

• Being sold an inappropriate or unsuitable fixed annuity
• 10% IRS penalty on withdrawals prior to 59 1/2 years of age
• Early withdrawal penalties or surrender charges for large withdrawals prior to maturity or when withdrawing in excess of the 10% annual surrender free portion
• Ordinary income tax owed on earnings during the withdrawal or income payout stage
• LIFO: Last in first out tax requirement so earnings are taxed first, unless annuitization takes place, which then uses a tax exclusion ratio
• Fixed index annuities are not FDIC insured
• Fixed index annuities do not capture the full upside of the stock market
• Caps, participation, spreads and declared fixed interest rates are all subject to change on an annual basis
• It is possible during a down year or years to have zero interest crediting

Fixed Index Annuity Benefits

• Safety: Backed by highly rated state regulated insurers
• Tax Deferral: Tax-deferred growth
• Higher Return: Better interest rates typically than CDs
• Life Insurance: Death payout **guarantee options
• Liquidity: Flexible withdrawal privileges
• Unlimited Contributions, unlike IRAs and 401(k)s
• Inheritance: Pass money directly to heirs by passing probate
• Lifetime Option: Income you can’t outlive (Annuitization or a Living Benefit Rider)

Fixed Annuity with Indexing Options

[FIA, Fixed Index Annuity]

• Lump-sum or periodic contributions
• Invested in mostly high quality bonds
• Annual interest crediting risk. Insurance company **guarantees principal.
• Higher rate potential based on index performance (such as S&P 500, Dow Jones, NASDAQ, etc.)
• Moderate growth
• 4% to 8% interest crediting potential varies with index performance
• 3- to 14-year term
• Sophisticated, greater potential
• Guaranteed retirement income options
• Annual fees, minimal to none

Summary of Pitfalls for Fixed Index Annuities

Investors that need their money prior to retirement may prefer a CD, money market or securities investment to avoid the potential 10% IRS tax penalty imposed for taking money out of an annuity prior to the age of 59 1/2. For individuals at or near retirement, fixed annuities may be a better choice. If you’re looking to have a larger retirement nest egg, fixed annuities may help you meet that goal better than securities, CDs or a money market account.

Question: What is the difference between an insurance agent and a financial planner with a fiduciary responsibility?

Answer: As long as the insurance agent does not lie about the product or strategy, he or she can recommend it and receive their commission. They are allowed by law to withhold information about other products and strategies that may be more beneficial for the client. Consider using a fiduciary such as a Registered Investment Advisor. They are legally required to look out for your highest good regarding what they know would benefit you the most.