What The Informercials Don’t Tell You About Annuitieslegacy
We’ve all seen the infomercial on TV with the guy talking about “his” financial plan that can only go up in value and never go down. The offer sounds too good to be true, but he’s actually talking about a very common strategy for people who are close to, or already in retirement. That is – placing a portion of their retirement money in an Equity Indexed Annuity. You may not be familiar with that type of product so a brief explanation may be of some help.
Let’s start by explaining what an Equity Indexed Annuity is not. It is not a fixed rate annuity. That type of product is for a number of years, usually between 5 and 10, and guarantees a particular rate of return. Right now most fixed rate annuities provide a 2.5% to 2.85% return depending on the amount invested and the length of the contract. The upside – you are guaranteed a set rate of return no matter what the market does. The downside – you give up the flexibility to move your money if rates increase.
In addition, an Equity Indexed Annuity is not a variable annuity. A variable annuity combines the structure of an annuity with mutual funds investments. It is still a contract for a number of years, again usually between 5 and 10, but the rate of return is determined by the investments you select within the annuity platform. For instance, you could choose growth funds, income funds, sector funds, etc. The upside – there is no limit on your rate of return, and the gains are held within the annuity structure so you don’t have to pay capital gains tax until you withdraw your money. The downside – your return is only as good as the funds you select. If your funds go south – your nest egg goes south with them. Simply put, variable annuities involve more risk and some retirees may not feel comfortable taking a loss during retirement.
The Equity Indexed Annuity is an annuity, usually between 7 and 14 year in duration, that bases it rate of return upon an index, which is typically the S & P 500. If the index goes up, the annuity goes up in value with a cap, spread, or participation rate limiting the upside potential. If the index goes down, the annuity receives a 0% return for that year. The upside – it is a good choice for capital preservation. The value of the contract can only go up, and all gains are locked in. The downside – there is a limit on potential gains. If the market has a great year your returns will be limited. In addition, your funds will be committed to one financial strategy for a long period of time.
The final point on Equity Indexed Annuities is that many of these products have income riders that allow the annuitant to receive lifetime income from the annuity. This is a nice option for folks who are concerned about outliving their money, or want to know exactly how much they can count on during retirement. The income rider is not the same thing as annuitizing your contract. Annuitizing is a drastic step that includes the insurance company guaranteeing you a n sum certain for life, but once you die the balance of the contract goes to the insurance company instead of your family.
Consult a financial professional such as myself to find out more details on how these types of contracts work and see if they are a good fit for your situation.