Playing With A Stacked Deck - Equity Index Annuities

Bob Clark, a columnist for Investment Advisor magazine, recently said, "...the role of advisors is to protect their clients from the financial services industry". Many times the products pushed by the large financial service firms do more harm to investors than good. The "hot" product de jour is currently the Equity Index Annuity.

While the equity index Annuity itself is not an evil thing, the way they are presented to investors is many times misleading, and they are often pushed to be a much larger part of a portfolio than prudence would justify. Regulators have become so concerned that the SEC has issued an explanation of equity index annuities, and the National Association of Securities Dealers has issued an "investor alert".

In brief, an equity index annuity, provides returns that a related to some stock market index. As such they can be viewed as an equity derivative (remember those?). Investors typically receive a return that is some portion of the return of an index like the S&P 500 (for example 90% of the point to point return of the price increase of the index, not including dividends), the average monthly return of the index over a predetermined period (again not including dividends), or the monthly gain of the index with a predetermined cap (often 2-3% per month cap). The big draw is that you receive a guarantee that your account will not have a negative return over some period of time. Often touted as "heads you win, tails you don't loose". On the face that sounds enticing. It is only if you kick the tires that problems become apparent.

First, like most annuities there is a long period of time where you a charged a surrender charge if you want or need to withdraw more funds than allowed in the contract (I have even seen instances where the surrender charge is applied to any withdrawal except in the case of annuitization).

Second, any gain from annuities is considered to be distributed first, and taxed as ordinary income (you do not get favorable dividend of capital gain rate when you file your taxes), and any distribution before age 59 1/2 could be subject to a 10% premature distribution tax penalty.

Worst of all the returns investors receive will likely not measure up to expectations. A good place to find information on how different equity index annuities would have performed is available at Personalyze.org. The pitfalls of monthly caps and averaging returns is also available here. This site is great for comparing equity index annuities to each other but for the investor to make a true comparison the returns need to be compared to the benchmark. To give you a means to compare check the growth of a $100,000 investment in a equity index annuity given by Personalyze.org to the following values derived from the sites own data for an investment in the index (of course this does not include dividends). For the period 1970 through 1979 (considered a bear market era by personalyze) $100,000 invested in the index grew to $117,250. For the period 1990 through 1999 (considered a bull market era by personalyze) $100,000 grew to $415,762, and for the past 10 years an investment in the index grew to $202,657.

Technorati Tag Equity Index Annuity