Avoid the turbulent water of the market with smooth sailing with an Index Annuity.
Let’s face it, Index Annuities can be confusing to say the least. In sum, index annuities provide you with upside potential with protection from losses in the market.
As you near retirement, the possibility of a market downturn can be disconcerting. What if you could still participate in market returns with no downside risk? Sound too good to be true? Well, it can be done. Using an Indexed Annuity can be a great way to preserve your money while you money still significantly outpacing the CPI (consumer price index, or inflation). With an Index Annuity returns are calculated and credited to your account at the end of each year. If the market is down, your account isn’t. However, no interested will be credited to your account, but you didn’t suffer a loss. This can be particularly important when you are nearing retirement. Crediting options are in simplest terms: Strategies that can be used to determine how your money grows.
In a previous article, I spoke about “sequence of returns” and how pulling out money can have a significant impact on how long your money will last based on market returns. To recap: 2 retirees, both age 65, invest $1,000,000. Both averaged annual returns of 8% that grows to the same value after 25 years, but they experience their annual returns in an inverse order from each other. They both start taking withdrawals of 5% immediately beginning at age 65. However, one retiree starts taking withdrawals in an upmarket thus giving him the optimal environment to maintain his portfolio value over the long haul. Leaving him with over $2.5 million in his account even after taking a total cumulative withdrawals of $1.25 million over the 25 year period. Unfortunately, the other retiree had to start taking income in a downmarket, consequently his total account is depleted by the time he is age 83. This should start to shed a little bit of light on the importance of locking in market gains without the risk of potential loss using an index annuity. An index annuity guarantees income, locks in the gains each year with no downside. You receive the same income paid for your entire life using an income rider that can be added to an index annuity.
Now lets look at how interest can be credited to your account value, using different crediting options:
Option 1: Interest Rate Cap:
A “cap” is the maximum interest rate that can be credited to an account. For example, if the interest rate cap is 4.5% and the value of the S&P 500 rose by 7% in a given year, your account would be credited 4.5%. If the S&P 500 rose by 2%, you, account would be credited 2%. However, if the market fell 10%, you lose NOTHING!
Option 2: Participation Rates:
A participation rate determines what percentage of your account value “participates” in market returns. Lets look at an example: If over a given year the S&P returns 7%. If an annuity has a participation rate of 80%, the contract would be credited 80% of the S&P return of 7%, or 5.56%. However, if the market fell 10%, you lose NOTHING!
Option 3: Spreads
The index interest rate credited is determined by subtracting a “spread” from an index’s gain.
For example, if the S&P rose by 7% and the hypothetical spread is 2%, your account be credited 5% (7% return- 2% spread). However, if the market fell 10%, you lose NOTHING!
Option 2: Annual Point-to-Point
In my option this is the easiest to understand. The beginning index value is compared to the ending index value at the policy’s anniversary . If the ending value at policy’s anniversary is higher than the beginning, your account is credited. A participation rate, a cap, or a spread is applied to determine the amount of index credit you receive. However, if the market fell 10%, you lose NOTHING!
Lets talk a look at a comparison a market index performance to a Fixed Indexed Annuity
Consider you have $100,000 IRA invested in stocks that make up the S&P 500, and a $100,000 fixed index annuity
Looking over a 19 year period (2001-2019), lets see how Fixed Indexed Annuity would have locked in gains during times of market declines:
Now bear in mind “sequence of returns”. Yes, the account value with stocks that make up the s&P 500 would have had a higher ending account value, but look at the first 8 years! Imagine if you had been making withdrawals at that time? You would have run out of money whereas making the same withdrawals with an index annuity, those withdrawals would still be continuing to this day!
I do hope this has provided some insight how index annuities work. They are not for everyone just as some stocks are not for everyone. However, when you are retiring are already retired, consider it as part of your portfolio. If you have any questions, always feel to call us Toll Free: (855) 664-5660, Asheville NC Location: (828) 513-5045, Greenville SC Location: (864) 214-7285
or you may email me personally at firstname.lastname@example.org