Indexed Annuities Explained
Let’s jump into indexed annuities, and explain how they work, just as I would explain it to a client.
The indexed annuity started around 1995 and was the answer between the fixed annuity and the variable annuity. People say, “I don’t like a fixed annuity because my interest rate is too low. I don’t like variable annuities because of the high fees and losing money on the principle.” So the fixed indexed annuity answered those objections. In a nutshell, how fixed index annuities work, is that as the market goes up, you get a portion of the gains, and if the market goes down, you stay flat.
I have a chart that talks about the real benefits of indexed annuities, and it shows how it has factually performed at a 50% participation rate since 2000. It’s a very powerful chart because people often say, “Well, I need to risk money to make money. That’s what I’ve been told. That’s what my broker said.” That is a complete lie. I always respond to that by saying “No, you need to risk money, so your broker makes money…if you don’t have money at risk, your broker is not making any money, so they want to keep you at risk to keep making their fees.” That’s why brokers use statements like, “Let it Ride” or “Don’t worry, it will bounce back.” The fixed indexed annuity simply allows you to get a portion of the gains and none of the losses. Now, all index annuities base everything on three factors. You have the cap rate, known as the ceiling which is the highest amount you can make. You have the participation rate, a percentage of the index growth that you make, and then you have a spread. The spread is everything you would get above what the insurance company retains.
For example, let’s just say the index makes 10%, and you have a 5% cap. That means the most you can get in that index is 5%.
Let’s say you have a 60% participation rate. That means that you participate in 60% of the growth, so out of a 10% index gain, 60% of that growth would be 6%. What you make in that case is 6%.
The last one is the spread. If you have a 3% spread and the index made 10%, you get everything above the spread. So 10% growth minus 3% means you made 7% total.
Now, also in an index annuity, you could have some that have death benefit riders or you could have some that have income riders, and there’s usually a fee attached to those as well. If you have an income rider in an indexed annuity, you’re going to have an income rider fee (most of the time). There are rarely any fees other than that. Some newer annuities have come out that have a fee on the index. I don’t like those types of annuities because attaching an index fee to a product means that if the index doesn’t have any growth, and there’s still a fee, you could go backward. You can have an indexed annuity with a 1% fee on the index, and the market stays flat, but your client lost money because the 1% fee comes out no matter what… I don’t like that. I like telling my client in a fixed indexed annuity the money can never go backward due to market volatility. Now, of course, you have your rider fee, if you have a rider, that can happen, but due to market volatility, your account value and your income value cannot go backward.
So why do I like the fixed indexed annuity? Because it allows my clients to participate in some of the growth with none of the market risks, with the ability of also attaching an income rider. People way over-complicate the indexed annuity. Can we go into the total back end of index annuities and try to explain exactly how all the inner workings come together? Absolutely, but you don’t have to because the reality is, we’re not trying to hide anything, and they are not that complicated.
Remember, always include the buyer’s guide, all brochures, all illustrations, and all disclosures, when you meet with the client. Leave that with them because you want everything you said to have a complete representation of what it factually does. Then you want the clients to read over all that information and you set another appointment to go over questions because you want them to understand the concept behind it.
We get to help people secure their retirements, not over complicated it. Understand how the Fixed Indexed Annuity works, and explain it in a way that the client understands too.