The risk with fixed indexed annuities

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In uncertain times, investors often seek the security of the principal. Fixed index annuities are a popular place to seek financial security, but they come with risks that consumers should be aware of.

The performance of a fixed indexed annuity is based on the growth of an external index. If the index is positive, you are credited with interest based on your participation in the index. However, when the index is negative, you don’t lose money. Your capital is tied up each year and does not participate directly in the stock market index.

While you are guaranteed not to lose money due to market losses or indices in a fixed index annuity, you are not guaranteed to make any money. But that’s not the only risk.

Traditional fixed indexed annuities are designed to renew their rates each year, and the annuity company could increase, decrease, or maintain the rates it pays. This means that with this type of annuity, participation rates or credit strategies may change from year to year. Each year, the policy owner receives a notice in the mail indicating what the rates or credit strategies will be for the following year. If the annuity company is unsure of what the near-term future holds, it has the option of lowering its rates each year. When the economic uncertainty around COVID-19 began, some annuity companies lowered their rates.

Obviously, this is an issue that can give the investigated consumer a reason to take a break from purchasing an annuity, and this is important because annuities are long-term contracts. No one wants to be stuck in an underperforming annuity. This could cost the annuity owner thousands of dollars.

Another option: pensions with participation rate

A handful of companies have found a solution to the renewal risk rate. They have developed annuities that guarantee what is called a participation rate for the entire term of the contract. The participation rate limits an investor’s earnings to a certain percentage of the return of a given index. For example, let’s say you have an annuity with a participation rate of 70% and the index to which it is linked gains 10% that year – your gain would be 7%. If the index ends the year with a loss, you don’t gain anything (but you don’t lose anything either). The annuity holder cannot decrease the participation rates. This allows the fixed indexed annuity owner to have confidence that annuity rates cannot fluctuate.

So, if you are considering using any of these annuities, it is important to understand that while the participation rate is guaranteed, you will not necessarily earn a guaranteed return. The annuity uses an index like a mirror or a gauge of how well the economy is doing to determine how much the contract holder will earn. What the guaranteed participation rate means is that the annuity company guarantees that you will receive a specific percentage of whatever the index returns.

Get the details before you commit

This isn’t to say that traditional fixed indexed annuities that renew rates every year are all bad, but it is advisable to look at the rate renewal history of the specific company to determine what you can expect to earn if you own this annuity.

Then ask for an illustration from the company or advisor who assists you. Normally, the illustration shows how the annuity would have behaved over the last 10 years, the best 10 years and the worst 10 years. This information will help eliminate financial surprises from your annuity and can help you develop reasonable expectations for your annuity.

When you combine a Guaranteed Participation Rate with a Volatility Control Index, life becomes even sweeter for the contract holder. In the past, indexed annuities primarily based their rates on the S&P 500. If the S&P 500 works well, you might be successful in the annuity. If the S&P 500 hurts… well, you don’t lose anything because your capital is protected. You might not earn anything that year, but remember zero is better than a negative number on any day of the week!

Several years ago, annuity companies began partnering with asset management firms, such as Janus Henderson, to develop indices like the Janus SB Global Trends Index, which attempt to control the volatility of the index. The way companies like Janus try to achieve this is to combine an equity component like the S&P 500 that most annuities use while adding bonds and commodities.

The thinking process is that if the stock market was negative that year, then maybe commodities would be up. This would allow the index to control volatility and try to create more consistent and stable returns. I believe we’ll start to see more annuity companies offering guaranteed rates and using custom indices for the reasons outlined here.

A hedge against market volatility

While the stock market has historically moved for the long term, we’ve known for a few years that it can be a bumpy ride along the way. Using a fixed indexed annuity to mitigate market fluctuations may be a solution to consider for a portion of your portfolio as you approach retirement or when you retire.

Historically speaking, we have seen that it takes a few years for the stock markets to recover from losses. While the market quickly recovered from its 2020 lows, that’s not always the case, and who’s basing what’s normal in 2020 anyway?

In retirement, if you are withdrawing income from your savings and the stock market is down, this can be problematic. Cutting down on your assets when they’ve been hit by the market is a double whammy. This is one of the key aspects against which a fixed indexed annuity protects. Using an index annuity for part of your portfolio may be worth considering.

This strategy may even allow you to take more risk in your equity positions because you know your annuity money is safe from market losses. The fixed index annuity has a range of uses, but the best recommendation is to find a qualified advisor who is familiar with the changing world of fixed indexed annuities. A qualified advisor can help you determine if an annuity is right for your portfolio.

We are a financial services company that uses insurance and investment products. Investment advisory services offered only by persons duly registered through AE Wealth Management, LLC (AEWM). AEWM and Excel Clients, LLC are not affiliated companies. All investments are subject to risk, including the potential loss of capital. No investment strategy can guarantee a profit or hedge against losses in times of declining values. Any reference to guarantees or lifetime income generally refers to fixed insurance products, never to securities or investment products. The guarantees for insurance and annuity products are supported by the financial strength and claims capacity of the issuing insurance company. Neither the firm nor its agents or representatives can give tax or legal advice. Individuals should consult a qualified professional for advice before making any purchasing decision.
The appearances at Kiplinger were secured through a public relations program. The columnist received assistance from a public relations firm to prepare this article for submission to Kiplinger.com. Kiplinger has not been compensated in any way. 854496 – 3/21



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