Annuity Q (not for income)

[Broland]

Moving money around and I stumbled on an annuity with a 6 year term that gives S&P500 index plus 108% participation and 10% buffer. Zero cost, of course penalties for early withdrawal. They also offer a 103% participation and 20% buffer option.

I am 85-90% equities (a very conscience decision, no need for comments on that) but I did like the appeal of this annuity as a "lower risk" portion of my portfolio. Zero chance I'd need to withdraw early so no penalty.

Downsides/upsides/thoughts?

 

[RetiredHappy]

I used to buy something similar from Merril Lynch, called market/index linked step up notes. They had a 20 percent down buffer, and growth was directly linked to whichever index, say, S&P. The downside is that they pay no dividends. Some had a small bump depending on participation level, i.e. how many are sold.

Downside - no dividends. Upside - you get all the index growth and a 20% down buffer.

 

[Broland]

Ah! I haven't seen the contract yet and (of course) no dividends were mentioned! THANKS!

 

[MarieIG]

What is the "worst case scenario" with this investment?

 

[RetiredHappy]

What is the "worst case scenario" with this investment?

It's backed by the issuer, so you have to make sure that you buy from a reliable / A++ issuer. If it goes bust, you lose all of your money. Merrill Lynch sold me the ones that were issued by Bank of America, so that was pretty safe.

Otherwise, there are not alot of downside, other than you don't get dividends.

Also, don't buy the ones that are linked to commodities because they can be pretty unsafe. Stick to the ones that are linked to S&P and Dow. I haven't seen ones that are linked to Nasdaq.

 

[TheWizard]

I don't buy annuities except for immediate lifetime income. I do have one tied to CREF Stock (QCSTIX) that adjusts my monthly payout depending on how well that fund performs compared to a 4% Assumed Investment Return (AIR).
Stocks have gone up considerably since I started that in 2013 and so has my income from that source...

 

[RetiredHappy]

I don't buy annuities except for immediate lifetime income. I do have one tied to CREF Stock (QCSTIX) that adjusts my monthly payout depending on how well that fund performs compared to a 4% Assumed Investment Return (AIR).
Stocks have gone up considerably since I started that in 2013 and so has my income from that source...

What OP asked is not a "true" annuity. It's just another way to buy into the index, with a 20% downward protection. Unlike variable annuity where there is smoke and mirrors with all kinds of high commission, this one is very straight forward. What you see is what you get. Gains on maturity, 5/6 years, are taxed as capital gains if you buy it in your taxable account.

 

[TheWizard]

...Otherwise, there are not alot of downside, other than you don't get dividends....

Not familiar with that ML product but with most Variable Annuities, TIAA's specifically, dividends get get automatically reinvested into the VA, thus increasing its NAV a bit...

 

[RetiredHappy]

Not familiar with that ML product but with most Variable Annuities, TIAA's specifically, dividends get get automatically reinvested into the VA, thus increasing its NAV a bit...

OP's product is not a variable index annuity. It's a straight-forward investment that goes up 1:1 or higher (1:03:1 / 1:08/1) compared to the index. No smoke and mirrors. There are many issuers of this type of products, usually sold by banks or investment firms like Merrill Lynch. The last one that I bought was issued by HSBC and sold by Merrill Lynch. I stopped buying it because we separated from Merrill Lynch and I also hated paying 6 figures in capital gains once it matures. Maturity can be 3, 4, 5 or 6 years depending on what you buy.

 

[zinger1457]

Can someone explain what the 108% participation and 10% buffer means? Does the buffer limit your loses and the participation limit your gains?

 

[RetiredHappy]

Can someone explain what the 108% participation and 10% buffer means? Does the buffer limit your loses and the participation limit your gains?

Yes, if it drops 10% or less at the end of the period (6 years for a 6 years note), you get back what you paid into. 108% participation means that they can pay up to a maximum of 8% above the index value when it matures. The gains are what the index + 8%.

So if S&P is 6000 today and the note starts today. At the end of 6 years, the S&P is 9000, you get 8 percent above 9000. If S&P drops to 5400 at the end of 6 years, you get back what you paid for and 8% above it. I am not 100% sure of how the 108% is calculated, but I believe it is based on how many of these notes are sold.

 

[Koolau]

What does it cost one in fees and trading costs, etc? Sounds too good to be true but perhaps I don't understand it.

(If I don't understand it, I don't buy it, but YMMV).

 

[RetiredHappy]

What does it cost one in fees and trading costs, etc? Sounds too good to be true but perhaps I don't understand it.

(If I don't understand it, I don't buy it, but YMMV).

No fees at all. The broker/seller gets commission from the issuers of the notes. At one point, I bought 3 $150K, total of $450K in 5-year step up notes, laddered over 3 years. My problem is that they were all taxable money, so I ended with hugh capital gains when the notes matured.

 

[Broland]

Yes, if it drops 10% or less at the end of the period (6 years for a 6 years note), you get back what you paid into. 108% participation means that they can pay up to a maximum of 8% above the index value when it matures. The gains are what the index + 8%.

So if S&P is 6000 today and the note starts today. At the end of 6 years, the S&P is 9000, you get 8 percent above 9000. If S&P drops to 5400 at the end of 6 years, you get back what you paid for and 8% above it. I am not 100% sure of how the 108% is calculated, but I believe it is based on how many of these notes are sold.

I was told (haven't seen the contract yet) that each year at contract sign day is the "settlement" for the year where the up or down is calculated.

 

[RetiredHappy]

I was told (haven't seen the contract yet) that each year at contract sign day is the "settlement" for the year where the up or down is calculated.

Then it is different from the 3 that I bought, 2 were issued by BOA and 1 by HSBC. The settlement dates for them were 5 years later, on maturity.

 

[Broland]

Here is the reply from the advisor I'm working with:

"Market is up 25% (including dividends, you do receive that as part of the calculation) 25% x 1.08 = 27% net return in your account. This will happen each year during the 6 year duration"

Sounds pretty good ...

 

[RetiredHappy]

Here is the reply from the advisor I'm working with:

"Market is up 25% (including dividends, you do receive that as part of the calculation) 25% x 1.08 = 27% net return in your account. This will happen each year during the 6 year duration"

Sounds pretty good ...

How does the fund decide on the amount of dividends? Do they use VOO or similar S&P 500 ETF dividend payout? I will be very careful with anything that is not in writing.

 

[all4j]

Sounds to me that you are looking at a “Registered Index Linked Annuity” of some sort. You are wise to review the prospectus as these come in a wide variety. If you have the product name, you can likely find it online (& share with the board to get better detail?).

These annuities will have a “cap” on the upside. You basically forfeit any gain over the cap (as perhaps adjusted by participation rate) in exchange for buffer on downside. The cap may be reset during the term. They are usually quite complex with terminology that is unique to their company, making them very confusing. Sold, more than bought, to investors that don’t seem to have your risk tolerance & financial aptitude.

They do have cost – commission, fees, etc – whether explicitly stated or plowed into their calculations & that should be understood if you are doing any comparison. You might want to compare them to buying a put option if downside risk is your primary concern. Otherwise, I'm not sure this would be useful to you.

 

[copyright1997reloaded]

Another alternative are the buffered ETF's. For example, Calamos offers them monthly:
https://www.calamos.com/capabilities/structured-protection-etfs/

I bought a small amount of the Sept 2024 one just to watch it. As of today, I have a 5.5% gain in it. Since the SPY is up 10.37% and the cap on the upside is 7.5%, it should rise to the cap (approximately) as long as the SP 500 remains over the cap.

This is a semi-meaningless investment for me, I should spend some time pondering using more of these in my tIRA.