The idea of having a savings vehicle that can take advantage of the market upside while protecting your money from market downside sounds extremely promising. This is the usual description of a Fixed Index Annuity. But how do you choose which Fixed Index Annuity? Annuities have now many different options built into them and it make them harder to compare.
To answer that question accurately, you first need to ask “What is the primary purpose of the money?”
For example, many of my clients are now looking for annuities to provide a guaranteed income stream for life. But they also want the remaining money they have not yet withdrawn to have the potential to grow while still having access to it.
Let’s take an example of a 60 year old who wants to take half of his 401K using his in-service withdrawal option and put it into an annuity (for more information on in-service withdrawals see my post on 401(k) withdrawals). His plan is to retire from his job at age 66 and start taking an income from both Social Security and his annuity.
In this scenario, his main goal for the annuity is to have the highest guaranteed income stream; however he wants the flexibility to have access to his cash accumulation and wants the cash value to have the possibility to continue to grow.
When you are comparing annuities in this scenario, it is tempting to look at the guaranteed growth in the income account, often referred to as the rollup rate. Some are as high as 14% right now. But make sure you look at the payout rate at age 66 as well.
The actual money in your pocket is determined by the total amount in your income account (sometimes called withdrawal benefit value) multiplied by the benefit or payout rate. The average payout rate is about 5% at age 66 and should increase with age depending on when you initiate the income stream.
Guaranteed lifetime payout rates on $100,000 for a 66 year old can vary from $3,400 per year to over $8,000 per year so do your homework!
But you cannot ignore the account value even if your primary goal is income. The account value in most cases is what you can withdraw from if you need additional money than just your income amount, and it is usually the amount you leave to your beneficiary. It is also the remaining cash value of your annuity where gains are tied to an index, yet your principal is protected. If it increases higher due to market gains than your withdrawal benefit value than it may also increase your guaranteed income stream.
In this case, how would you compare fixed index annuities?
First look at the guaranteed income, after all that is the #1 goal. Second, look at how the account value grows. If it decreases very quickly, you end up with a glorified immediate annuity with little flexibility, defeating the purpose of having an annuity with an income rider. Pay attention to the rider fees as well. These are not necessarily bad because usually the higher the fee the better the guarantees, however there are some good annuities that will not charge a rider fee if there is no gain in the account value.
If you do not plan on taking an income stream and want a Fixed Index Annuity to protect your principal while having the potential for growth, then you want to compare crediting history and potential. Most Fixed Index Annuities will allow you the option to have money in different index and/or fixed accounts. With the fixed accounts, you can compare the rates similar to CDs.
But the indexed accounts can be more difficult to compare. There are participation percentages, caps, and spreads that determine how money is credited to your annuity account. It is very important you work with an agent who represents several companies and can compare these annuities in a clear way. If you like having lots of options on how your money can be credited, consider an annuity that has more than one or two options. There are index annuities that even have a gold index option or a reverse crediting option – if the market goes down you get credits.
If you want to keep it simple, consider the S&P index which most Fixed Index Annuities offer and look at participation rates and caps. The participation rate is the percentage of your principal that is used to calculate the gain in the index. For example a participation rate of 60% indexed to the S&P for a $100,000 annuity would take $60,000 times the growth of the S&P and usually has no cap (limit) in the growth. That amount would be credited to your account value, and once it is credited it cannot go down.
Cap Rates will put a cap or limit on your growth either yearly or monthly. That same principal deposit of $100,000 would be multiplied by the growth of the S&P, but would be limited to the growth say 7% cap per year so $7,000 would be the maximum amount credited to your account per year. Again, once credited it can never go down.
There are other reasons people get annuities, some for the additional benefits it can offer called enhanced benefits that pay extra income if you have chronic or critical care issues. Perhaps you could not qualify or do not want long term care insurance but want a feature that offers increased payments if you need care. Or perhaps you are concerned about inflation and want to add inflation protection on the annuity payouts. Often clients want to leave their full IRA to their spouse or beneficiary even after taking the Required Minimum Distributions. In this scenario, you want to look at high guaranteed death benefits on the annuity.
When comparing annuities the first question to ask is “what is the most likely use for the money?” Second, you want to compare those features with the other annuities that offer similar features to insure you are getting the best annuity for your most likely scenario. Third, you want to look at the flexibility of the annuity in case that scenario changes.
To learn more from this educator, click here (Laura Johnson).
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