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Q. Jeff, I've been approached by
someone touting the benefits of equity indexed annuity with
“Company-X”. They say my money will be safe, there’s a minimum
return and a cap with a participation rate of 100%. They also said
I’d probably average between 6%-7% without any risk to the money I
put in. I'm confused by all this. Any help you can give would be
greatly appreciated!
A. I’d be happy to help. It’s completely false when they say you
should earn 6-7% per year without any risk. The only 'guarantee' on
any equity-indexed annuity is the guaranteed minimum rate. On
Company-X’s equity-indexed annuities, their guarantee is 3% on 75%
of premium.
As you can tell, they aren’t interested in making equity-indexed
annuities easy to understand. 3% on 75% of premium means that you
are only 'guaranteed' a minimum of 2.25% on the full amount you
invest. If you put in $100,000, they’ll pay you 3% on $75,000, or
$2250 in interest.
Why don't they just say they'll pay you 2.25%?
The rest of the 6-7% return they say you should safely earn is
entirely based on the stock market. More correctly, you are
guaranteed of earning 2.25% if you leave all of your money in the
equity-indexed annuity for 10 years. Any additional earnings are
subject to the performance of the stock market.
They aren't even straight with the market-based returns. You either
have the option of "yield spread deducted from average monthly
positive gains or cap with no spread ".
The Spread Option: Your contract is broken into monthly periods and
the return for each period calculated. That gives you 12 one month
returns. Those are added together and divided by 12. Lastly, the
'spread' is deducted from that average.
I don't know what their spread is (and they can change it anyway),
but if it were 3%, they’d then subtract 3% from the average I just
mentioned. Let's say your average was 7%. 7%-3%=4%. So they’d credit
you 4% for that contract year.
The 100% option: You get 100%, but only up to the cap, say 9%. So if
the index goes up 9% you get 9%. If it goes up 23% like in 2003 you
still only get 9%. And they can change the cap.
The bottom line is that you’re locked into an equity-indexed annuity
and they control everything. They can change how your return is
calculated from year to year and you have no recourse.
Q. You stated they can’t guarantee 6-7% as my return, but that the
return would be based on the average of the S&P 500. What was the
average for the last ten or so years? And wouldn’t that be my
return? Company-X has a 100% participation rate and that sounds
good, but they said there is a 7% cap on the interest rate. That
sounds pretty decent in comparison to what I can get on a fixed
annuity. What do you think?
A. As of 2/18/2005, the 10 year average annual return of the S&P 500
was 11.5%. You participate 100% but only up to the cap--7%. For
instance, in 2003 the S&P 500 earned 23%, but this EIA would have
only earned 7%. Last year, the S&P 500 earned over 10% with
dividends reinvested. This EIA would have only earned 7%.
That’s a huge difference. $100,000 earning 7% for ten years will be
worth $196,715. The same investment at 11.5% will be worth $217,852.
That is $21,137 more. Put differently, you will earn 21% more over
ten years at 11.5% then at 7%.
You shouldn't compare an equity-indexed annuity to a fixed annuity.
A better comparison would be to a variable annuity because none of
the returns of a fixed annuity are subject to the stock market.
I don’t have any financial incentive in the advice I’m offering you.
On the other hand, the person recommending the equity-indexed
annuity will probably make a 10% commission and will provide little
or no service after you sign you up. Did they mention that?
I love to answer reader’s questions. If you’d like free, unbiased
advice submit your questions to www.guardingyourwealth.com/askjeff.htm. Read
answers to questions other readers have asked on the Q&A page at
www.guardingyourwealth.com.
Mr. Voudrie is a Certified Financial Planner®, nationally syndicated
newspaper columnist and President of Legacy Planning Group, Inc., a
Private Wealth Management Firm in Johnson City, TN. You can reach
him toll-free at 1-877-827-1463 or by email at jeff@guardingyourwealth.com
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