Finding safe, guaranteed income

Money is pouring into index annuities at a rapid rate. They’re the annuities with the highest sales in most recent years, so it’s not surprising.

An index annuity is a good place to put some investment dollars. You have the potential to earn a higher return than traditional safe investments but are guaranteed both a minimum return and return of your principal. The better the stock market does, the higher your return is; but you don’t share in stock market losses.

But too many people are buying the wrong annuities.

They’re earning lower returns than they should, paying too much in fees, or adding bells and whistles they don’t need or that aren’t worth the extra fees. They aren’t buying the annuities; they’re being sold them.

Index annuities are a simple concept that quickly can become complicated. An investor deposits money, usually a lump sum, with an insurer. The insurer invests the money in its own account and promises to credit income to the investor’s account each year. Most index annuities now guarantee the income for a year won’t be less than 0 percent, but guaranteed annualized returns over the life of a contract can go as high as 3 percent. It depends on the insurer and your state’s rules.

That’s only the minimum return. They’re called index annuities because your annuity has the potential to earn more; and the higher return is pegged to the performance of a public index, usually a stock market index. This is one of the places where an index annuity can become complicated.

You don’t earn the full return of the stock index. The annuity has a formula that determines how much of the index’s return is credited to your account. There are four basic formulas, but a lot of variations are allowed within the formulas. For starters, the annuities will have different formulas for computing the index return. Then, most limit the amount of the index’s return you receive, known as the participation rate. An annuity, for example, might be credited only with 50 percent of the index’s calculated return. Most index annuities also have a cap, or a maximum annual return, regardless of how well the stock index does.

The result is that when the index rises 12 percent, some index annuities will be credited 5 percent while others receive 10 percent.

You need a basic understanding of the annuity’s formula; but more importantly, you need to know the crediting rate. Ask what the annuity’s current crediting rate is and for examples of how much the annuity will earn (after fees and expenses) when the stock index returns certain percentages. Also, ask what the recent history is for the annuity or similar annuities from the insurer.

There are other factors to consider, such as the financial strength of the insurer, surrender penalties, bonus interest and more. You also have to consider withdrawal options, including income guarantees.

It’s easy to see the appeal of index annuities. They’re a good alternative for conservative investors and for the conservative part of a portfolio that otherwise might be put in intermediate bonds or similar investments.

With an index annuity, your principal is safe and a minimum income is guaranteed.

But you also have the potential to earn more than bonds, because your account’s income increases when the stock market does well. It’s a way to participate (but not fully) in a bullish stock market without the risk of losing money when the market heads south.

The complications scare people away or leave them uncertain that they bought a good annuity.

— Bob Carlson

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Bob Carlson