Wealth Management & Financial Planning

Wealth Management & Financial Planning

What to Know About Equity Index Annuities

Few if any investment products are so flawed that they serve no purpose. However, one notorious investment product is rarely explained or administered correctly. Although Equity Index Annuities (EIAs) may serve a purpose when used in the right manner, I’ve never recommended these products due to several concerns.

According to advocates (salespeople), EIAs offer a rainbow of promise. “Mr. Prospect, how would you like the certainty of never losing any money and the opportunity to enjoy a portion of what the stock market earns in good times?” Such promises can sound tempting, even to professional money managers. EIA pitches can seem even more lucrative to retired individuals.

This is where working with a fiduciary comes into play. We must not make long-term decisions based on promises. The Fiduciary Focus scraps promises in favor of focusing on four key areas: risk and volatility; fees and expenses; taxes both today and tomorrow; and real return.

EIA’s allegedly deal with risk and volatility by reasoning that investors can’t lose money. A more accurate statement is that EIA investors can’t lose principle, although they can clearly lose purchasing power. This reality can be viewed through the lens of real return and the impact of lost purchasing power. The word “risk” conveys negativity in our minds. Many seniors are especially averse to risk. In investment realms, risk simply means getting an outcome different than you expected, whether positive or negative. Yes, guarantees on EIA’s do limit downside forces on investors’ principle. But, they also severely limit the growth on investors’ money in up markets with caps.

“But the salesman said we would get up to 70% of what the stock market earned,” said an investor. And since the salesperson also noted and that it averaged over 10% in the long haul, the investor reasoned he could earn 7% risk-free. Sadly, his reasoning was wrong. The stock market has averaged over 9% over the long haul, but that includes dividends. EIAs are created with futures contracts and there are no dividends. Without dividends, the market has averaged in the high 5% range. Let’s just call it 6%. That means at 70% of the return, the investor would earn 4.2% on his money.

The second Fiduciary Focus concern is fees and expenses. Here, EIAs function in stealth mode. Investors don’t see the charges. The products have long surrender penalties that can last longer than a decade. Additionally, early withdraws can impose 10-12% surrender charges. Talk about fees!

The taxes on all annuity products are deferred until the time of withdrawal. Many of these contracts hold IRA money which is already tax-deferred. This should be illegal in my opinion. There is simply no rationale that justifies this, beyond the salesperson’s commission.

Real return addresses inflation. The small rate of return discussed earlier may sound better than banks’ returns right now. But inflation can change everything, especially over a 10-year surrender period. Purchasing power is clearly at risk over the life of the investment.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

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