Fixed and Fixed Indexed Annuities may be the most misunderstood retirement vehicle of all time. But are they really that complicated?
After the introduction of the first fixed indexed annuity back in 1995, just about every non-insurance based advisor (broker, banker) made sure they let the world know just how terrible and complicated they thought this financial product was. We've heard it all and promise to address that issue in a future article.
Today, just about all of them now offer fixed and indexed annuities (FIAs) and if they don't, they are doing a disservice to their clients who have a lower risk tolerance making securities unsuitable, but need more guaranteed benefits than banking products provide.
So what changed about FIAs where brokers and bankers would now start offering them? Nothing. By and large, they are very much the same as they were back in 1995.
So how is it that a financial product could get such a bad rap? Myths, lies, omissions and outright ignorance. It should come as no surprise every financial institution and advisory firm is competing for the same business, and when a financial product comes along that has the potential to take significant market share and change the industry, well, the competition is going to start firing shots across the bow. Just about every fixed and fixed indexed annuity article I've read gets it wrong when discussing this important retirement income vehicle. The most common error I see is the author will, whether intentional or not, bring up characteristics of variable annuities and apply them to fixed and fixed indexed annuities.
Variable annuities and fixed index annuities are very different retirement vehicles. The cash in a variable annuity is directly invested in the stock market subjecting those funds to loses. Whereas the cash within a fixed or fixed indexed annuity is not invested in the stock market, instead in the case of a fixed indexed annuity the insurance company simply tracks the changes in an index, like the S&P 500 for example, to determine how much interest to credit to the account.
The key difference between the two is a variable annuity has the potential to earn all of the gains of the market and suffer all of the loses when the market does down. While a fixed indexed annuity only captures some of the gains of the market, but is never subjected to any loses.
So, what about fees between these two retirement vehicles? Another common misconception is fixed index annuities are loaded with fees like a variable annuity. Again, this is a complete fabrication. Variable annuities have expense and mortality fees along with the fees inherent in whatever they may be invested in. Fixed indexed annuities do not have fees. They work on a spread, very similar to how a bank makes money on CDs.
The insurance company earns X% amount of interest on their investments, typically takes 2% to cover their expenses and then gives the rest to their customers as fixed interest. In a fixed indexed annuity the customer can then choose to forego all or a portion of that fixed interest to participate in the various index options the insurance company provides; thus, giving the customer the potential to earn a higher rate of return. The percentage of the index change the customer is able to earn is usually set by a cap, which is solely due to the purchasing power the insurance company has with the fixed interest they earned to pay you.
Finally, annuities are often labelled unsuitable due to the commission paid to the advisor. That argument is a red herring. I think we all can agree that everyone should be compensated for the work they do, yet somehow writers and other double talking advisors twist the facts regarding advisor commissions on annuities. The average commission from an annuity is about 5%. This may sound like a lot of money being paid to the advisor; however, most advisors fully intend on servicing these accounts for the remainder of the clients life. This could mean the advisor could be working for a client for 10, 20, 30 or maybe 40 years. If we assume the advisor works just ten years for a client, that means the advisor technically earned just a half of a percent per year. At 40 years the advisor earned just .125% per year. Furthermore, the commission paid to an advisor does not come from the client's account. Instead it is paid by the insurance company. Consider the fact a fee based securities only advisor typically charges their clients anywhere from .5 to 1.5% per year directly from their account and that doesn't include the other expenses inherent in the various securities.
Nevertheless, despite all of the misinformation printed in articles and websites, their efforts couldn't stop the massive number of people investing large amounts of money into these accounts. They have and continue to be one of the most popular retirement vehicles, and now most of the banks and brokers have since stopped resisting and have joined the movement. In fact, by now you've probably been offered a FIA by your banker or broker.
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James Spicuzza may be reached at 727.939.9465 or by e-mail.
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