Fixed index annuities

[aln1117]

Looking for info on fixed index annuities. I know the bad on variable annuities but looking for the pros (if any) and cons on them.
What should some one look for when researching them?

 

[brewer12345]

You should be looking for the nearest exit. Run.

 

[Independent]

+1

If you don't understand it, don't buy it.

An indexed, deferred annuity (what the seller is probably pitching) is sold as an investment vehicle where you get the greater of a fixed return or some fraction of an index - typically equity such as S&P 500. The "some fraction of" is the rub. There is a wondrous array of methods of defining the fraction.

The insurance company does not have a magic money tree. They can only give you returns available to them in the market, minus their expenses (which can be considerable). They use derivatives of some sort to get exactly what they need, however ...

... simply investing some money in a fixed asset like a CD and some in an index mutual fund will give you the same practical effect. You're probably already doing that.

 

[aln1117]

I don't fully understand them which is why I'm asking the question. From what I do understand is they pay what the index return is (S&P) up to a certain max and the insurance company gets the amount above that. But it is protected if the market goes down.
What I'm trying to understand is what the catch is where and act are the hidden costs that seem to be difficult to find .

My portfolio does have cd and mutual funds but was looking to protect some of it when the market does make a downturn.

 

[capjak]

I have researched and read that FIA pay about the same as a CD with the potential to pay slightly more (expect about 3.5% return if market is average+). For that slightly more you give up liquidity and increased risk over a FDIC insured CD.

Stan the Annuity Man has some pretty good videos on how they work and what they do and do not do, plus they are entertaining.

They are sold to compete with CDs not the stock market.

 

[REWahoo]

They are sold to compete with CDs not the stock market.

That is why they were created but unfortunately that is not how many of them are sold.

"The opportunity to earn higher yields based on stock market performance with protection against market declines" is the typical marketing spiel used to push these products. Rewards with no risks is always a great selling point and makes for fat commission checks.

 

[aln1117]

Wahoo, how and when are the fees and commissions paid. From what I can gather they are paid from the expected gains above what the given annuity is set for.
So then in retirement years or approaching years is it best to tool into cd and more secure investments rather then lock up funds with FIA?

 

[REWahoo]

Wahoo, how and when are the fees and commissions paid. From what I can gather they are paid from the expected gains above what the given annuity is set for.

You'll have to look very carefully at the fine print in the actual annuity contract, which will likely be many pages long (the last one I looked at in detail ran more than 70 pages). The fees will be sprinkled within the contract and paid whether or not the gains exceed targets - although the payments may go up if exceeded. Commissions won't be mentioned as they are paid from the fees.

So then in retirement years or approaching years is it best to tool into cd and more secure investments rather then lock up funds with FIA?

I am not a fan of annuity products and avoid them completely. The reality is they along with other "secure investments" usually aren't as they almost always lack the ability to keep pace with inflation.

As I approached and entered retirement I simply moved to a more conservative asset allocation, going from 60/40 (stocks/bonds) to 40/50/10 (stocks/bonds/cash(CD's). Risk tolerance is a key factor in selecting an AA and posters here vary from 100% CD's to 100% stocks - and everything inbetween.

 

[MooreBonds]

From what I do understand is they pay what the index return is (S&P) up to a certain max and the insurance company gets the amount above that. But it is protected if the market goes down.
.

The catch in nearly all (maybe all?) of any product linked to an index value is that they often EXCLUDE dividends. Considering that the dividend yield for an index could be 2%+, you are losing 2% of the total return of the index to the insurance company. So just like a mutual fund having to overcome a 2% total expense ratio hurdle, the S&P index has to increase 2% just to "break even" for going ex-dividend for the various dividends in the index (because it drops 2% when it goes ex-dividend if the yield is 2%).

So when you hear that the S&P has returned 10% annualized over the long term, that (I believe) Includes dividends reinvested. Without any dividends, or reinvesting the dividends, you are not comparing it to a "10% annualized total return" that the salesperson keeps talking about. It's actually much less than a 10% annualized return.

 

[aln1117]

So if the S&P does 10% for the year and the annuity is FIA is 5% the annuity is taking the 5% . Is that where the fees and commission are coming from or is there some hidden print in the 50 pages that says they take it up front every year ? Also what is the average commission that is being paid to the so called advisor that is trying to sell them.

 

[REWahoo]

So if the S&P does 10% for the year and the annuity is FIA is 5% the annuity is taking the 5% . Is that where the fees and commission are coming from or is there some hidden print in the 50 pages that says they take it up front every year ?

No way to know unless you read through every detail on all the pages of the contract. You'll never know what you are agreeing to pay unless you do.

Also what is the average commission that is being paid to the so called advisor that is trying to sell them.

Good luck in finding out what the advisor makes in commissions. It isn't going to be in the contract and it isn't something the insurance company advertises anywhere.

 

[capjak]

So if the S&P does 10% for the year and the annuity is FIA is 5% the annuity is taking the 5% . Is that where the fees and commission are coming from or is there some hidden print in the 50 pages that says they take it up front every year ? Also what is the average commission that is being paid to the so called advisor that is trying to sell them.

My understanding from many conversations with FAs/internet etc is that the Insurance company buys bonds and options on the S&P 500. If the S&P 500 goes up 10% they get the options on 10% and give you 5%, if the S&P goes down the options expire and you get Zero and the Insurance company is out the cost of options.

The commission paid to the salesman varies on the FIA but can be 5%-10% dependent on the length of the contract (the longer the surrender period the more the commission). The commission on a FIA is supposedly paid out of the Insurance Company's profit from their products (FIAs, Life insurance, etc..) That is why sales people state no commission (i.e. if you put 100,000 in than 100,000 is what your account will start with).

Fees are paid when you add Income Riders to a FIA or any annuity. The fees for Income Riders can be .75% to 2% per year and are paid from your accumulation value (i.e. you pay the fees from your account). Some have LTC riders, Death Benefit riders, etc... which all add fees typically.

So very complicated as some FIAs are best for accumulation (i.e. slightly better than CD rates) or for income, just depends what you are trying to buy it for.
Disclaimer: I am not a FA or salesman of any of these products, I work in pharma industry so these are just my thoughts .....

 

[Chuckanut]

The catch in nearly all (maybe all?) of any product linked to an index value is that they often EXCLUDE dividends. Considering that the dividend yield for an index could be 2%+, you are losing 2% of the total return of the index to the insurance company. .

Wow! You are serious about that statement? I don't question your integrity, but that is so outrageous that I have a hard time believing it.

Like my old grand pappy used to say "Thanks for the warning".

 

[Independent]

I don't fully understand them which is why I'm asking the question. From what I do understand is they pay what the index return is (S&P) up to a certain max and the insurance company gets the amount above that. But it is protected if the market goes down.
What I'm trying to understand is what the catch is where and act are the hidden costs that seem to be difficult to find .

My portfolio does have cd and mutual funds but was looking to protect some of it when the market does make a downturn.

The problem is "they" can refer to multiple products, each with it's own participation ratio, cap, re-set, or what ever the ins company calls the various numbers within the contract.

I can generalize and say commissions are paid out of the difference between what the ins company earns and what the ins co pays the policyowner - you don't see a separate charge for commissions.

Identifying exactly where that margin is requires reading each specific contract and understanding all the moving parts, thinking about how the ins company invests to back the payouts (recognizing that some of those investments will be in derivatives), pricing the investments, and getting spreads.

That really isn't necessary for a decision to buy or not buy. What is necessary is that the buyer understands what he/she will get for a variety of possible future market paths. That's what I meant by "understand before you buy".

And, that requires looking at the very specific form that the buyer is considering, because each product is a little different from the others.

And, of course, then the buyer should compare that to the simpler approach of having a traditional mutual fund (maybe plus CDs) portfolio that includes both bond and stock funds.

That's a lot of work (or fun, it you enjoy techy numbers stuff).

Someone here would probably talk through a specific product with you, if you have one.

 

[OldShooter]

Wow! You are serious about that statement? I don't question your integrity, but that is so outrageous that I have a hard time believing it. ...

Absolutely true. I am putting together an intro investing class for the local school district and in the interests of field research I accepted a free steak dinner (quite good actually) in exchange for sitting through a huckster's pitch for indexed annuities.

He opened with an S&P graph (nominal S&P) covering 18 years (1998-2016) and asserting that the S&P had only returned 4% during the period. The real return, of course, was about 5.5% I haven't gone back to check but I'm sure the beginning point was cherry-picked. He was a very good huckster.

His closer was a graph that claimed (for the same period) that the S&P would have returned $207K on $100K while his product would have returned $224K with a much smoother ride. Of course, had he shown total return instead of nominal return, the S&P return would have been $262K.

For the OP: Read the wisdom in this thread until you absolutely understand this: Never, ever, buy anything you do not understand.

 

[aln1117]

Thanks for all the insight from everyone. So basically my so called "Friend/FA" is looking at his bottom line by telling me there are no up front fees or commissions but some where in the annuity they are costing me more then changing my AA.

This brings me to my next question with retirement hopefully within the next 5 years and trying to protect my nest egg what AA would be best.

 

[REWahoo]

...what AA would be best.

That's easy: the AA with the best return for the risk level you are comfortable with.

 

[OldShooter]

... So basically my so called "Friend/FA" is looking at his bottom line by telling me there are no up front fees or commissions but some where in the annuity they are costing me ...

Yes. Put simply, he is lying to you.

I forgot to mention (Post #15) that I also checked the huckster out here: https://brokercheck.finra.org/ He had an astonishing 22 customer disputes, with a number of them settled in the customer's favor for six figures. I have never seen so many on a brokercheck. He must have been a helluva rainmaker to keep from getting fired for this.

 

[GravitySucks]

That's easy: the AA with the best return for the risk level you are comfortable with.

+1
And make sure you can change it when you find you were wrong about your risk tolerance. Not ashamed to say my 80/20 was not realistic for me and a minor blip in the S&P taught me quick that 60/40 was better for my mental health.

 

[capjak]

Thanks for all the insight from everyone. So basically my so called "Friend/FA" is looking at his bottom line by telling me there are no up front fees or commissions but some where in the annuity they are costing me more then changing my AA.

This brings me to my next question with retirement hopefully within the next 5 years and trying to protect my nest egg what AA would be best.

There is definitely a commission. Not sure there are upfront fees for a pure FIA with no riders. All investments have fees and insurance (this is insurance not an investment) has even higher fees (thats why they have the big buildings).

For asset allocation I like Jane Bryant Quinn "How to make your Money Last and Bogleheads' guide to retirement.

I should also state that annuity contract insurance may be appropriate if you understand them and have realistic expectations. The most straight forward is SPIA and Deferred income annuity. Compare them to CDs not the S&P 500.

 

[mickeyd]

Thanks for all the insight from everyone. So basically my so called "Friend/FA" is looking at his bottom line by telling me there are no up front fees or commissions but some where in the annuity they are costing me more then changing my AA.

This brings me to my next question with retirement hopefully within the next 5 years and trying to protect my nest egg what AA would be best.

The FA is fudging. I have heard them claim "I don't get paid by the annuity/insurance company". He fails to mention that he gets paid by his agency. Of course the "friend/FA" has to make money on the deal and your money is the only source to dip into.

 

[OldShooter]

.. And make sure you can change [your allocation] when you find you were wrong about your risk tolerance. ...

Yes. It is very easy for any of us to theorize about our tolerance. It may be quite different when tested though.

One of my favorite quotations:

“Art cannot convey to an inexperienced girl what it is to truly like to be a wife and mother. There are certain things that cannot be adequately explained to a virgin by words or pictures. Nor can any description that I might offer here even approximate what it feels like to lose a real chunk of money you used to own.”

-- Fred Schwed, from "Where are the Customers' Yachts?"
​

 

[capjak]

"Fixed Index Annuities (FIAs) Also Have Steep Commissions
Even though indexed annuities have as short as a 4 year surrender period, the vast majority of FIAs are sold with a 10-year surrender charge. Let’s just say that the commissions are high, which explains why every Tom, Dick, and Harry agent just happens to lead their sales pitch with a 10 year FIA. The 10 year FIA typically has a commission from 6% to 8%. Some FIAs have a 15-year surrender charge, so you can only imagine how high those commissions are."


https://www.thebalance.com/what-levels-of-commission-do-agents-earn-on-annuities-146003

 

[aln1117]

I understand they need to make money and a portion of my investments are a source of income. But being a friend and someone who I would have hoped would put my money to work best for me makes me second guess anything he reccommends.
When I asked the question about fees and commissions and he was a little vague , that alone puts up the red flags.
I have never been one that liked annuities especially variable annuities is why I asked here. When I asked hm what other AA I could make to do the same thing without the fees he said there wasn't any that gave the protection from declines

 

[capjak]

I understand they need to make money and a portion of my investments are a source of income. But being a friend and someone who I would have hoped would put my money to work best for me makes me second guess anything he reccommends.
When I asked the question about fees and commissions and he was a little vague , that alone puts up the red flags.
I have never been one that liked annuities especially variable annuities is why I asked here. When I asked hm what other AA I could make to do the same thing without the fees he said there wasn't any that gave the protection from declines

May want to rethink the word "Friend".

You have options for Fixed Income (0%-4% interest return)you can Mix it up that is my plan: CDs (FDIC insured, low interest), Bond Funds , Treasuries , Multi Year Guaranteed I annuity , FIA

For higher returns I will be in the Market.