Saving for Retirement?
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Saving for Someone's Schooling?
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Equity Indexed Annuity Inquiry
An annuity can be an important weapon in one's quest to build their savings resources for retirement, regardless of the reason.... for enriching the retirement experience through scheduled annuity payments or for assisiting a grandchild, perhaps, with their educational needs.
Annuities are safe, secure, and stable as a means to plan and provide for family financial protection.
AND, an indexed annuity is ideal due to the guaranteed pricipal aspects (when left to term).
Following is information principally discussing indexed annuities, a form of the fixed class of annuities. The product which we have available is an equity indexed annuity (traditional fixed annuities are also available) that combines the safety of fixed annuities while crediting interest simulating the performance of the S&P 500. It includes concepts fundamental to fixed annuities and elements from more aggressive financial vehicles. Here is how it works.
■ The index term is seven years at the end of which, clients are guaranteed (assuming no withdrawals) to receive at least 110 percent of the principal which represents 90 percent of the initial premium accumulated with three percent interest. Interest earnings are tax-deferred.
■ Clients are credited interest based on a percentage (the participation rate) of the increase in the value of the S&P 500 at the end of the index term.
■ At the end of the seven-year index term, the client’s interest earnings are determined by measuring the change in the S&P 500 from when the contract was started and applying the participation rate. To help lower the effects of potential market volatility, the change is calculated using an average of the index’s value at the end of each of the last four quarters of the index term (the Asian method).
Let me know if you would like more information on an Equity Indexed Annuity.
General Annuity Basics:
An annuity is a financial product that guarantees to pay the annuitant a particular number of dollars
each year for a specified period, sometimes until death, commencing at some predetermined date.
Annuities serve two primary purposes; to accumulate funds on a tax deferred basis and to provide for
systematic annuity payout on various retirement income schedules (guaranteed income for life, over
two lives or over certain periods). They can also be paid in lump sum.
Deferred annuities generally offer the following features.
■ Tax deferral; interest earnings are not taxed until withdrawn.
■ Choice of retirement income options, including guaranteed lifetime options.
■ Long-term retirement planning and accumulation vehicle.
■ Safety of principal and earnings for fixed annuities only (the value of variable annuities varies
directly with the gains and losses of the assets in a separate account underlying the policy).
■ Probate-free death benefits, avoiding the delay and expense of this process.
■ In most cases, a penalty or surrender charge for early withdrawal (withdrawals made before age
591/2 also incur a 10 percent IRS penalty tax).
Available in single premium (one-time payment) or flexible premium plans (recurring periodic
payments), annuities can vary by payment mode. They also vary by timing of the annuity income and
may be available as a deferred annuity (annuity income payments are deferred until later) or an
immediate annuity (annuity income starts immediately). However, the most critical variation is how
interest earnings are determined and the degree of risk to principal and earnings that the owner bears.
In a traditional fixed annuity, the company offering the product declares a current rate of interest,
guarantees a minimum rate of interest and guarantees the principal. Rates are generally comparable
to other fixed income vehicles such as CDs.
The variable annuity is a contract with earnings linked directly to the performance of various
investment vehicles. The investments typically consist of common stocks, bonds or money market
funds. A greater risk factor is at work and the rate of return could either be higher or lower than a
fixed interest rate contract, depending on performance of the underlying portfolio. The investment
risk is assumed by the annuity owner.
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Equity Indexed Annuities
An equity indexed annuity has interest rates linked to growth in the equities market as measured by
an index, such as the Standard & Poor’s 500 Composite Stock Price Index. This product offers all the
features associated with fixed annuities plus interest earnings linked to an external index, while
limiting the uncomfortable downside risk. Equities have historically outperformed fixed income
investments and inflation, so interest earnings linked to this market have inflation-fighting potential.
Owners of equity indexed annuities enjoy the potential increases of an equities-based index but do not
bear the market risk; if held for the policy term with no withdrawal, their account value can only
go up. Equity-indexed annuities have developed an appeal with people receiving lump-sum
distributions from pension plans or IRA rollovers.
Indexing
Indexing is a strategy that seeks to match the performance of a defined group of securities that form a
recognized market measure or index. An index is a benchmark or relative measurement of
performance, like the Consumer Price Index that tracks the price of consumer goods from year to year.
Indexing only seeks to match or replicate the overall performance of the index, so the specific
securities and the quantity held is predetermined by the composition of the index.
The S&P 500
Although there are a number of indexes that could be used, most of the equity-based products
marketed within this country are linked to the Standard & Poor’s 500 Composite Stock Price Index
(without dividends), known as the S&P 500.
Here are some reasons why.
■ It is a widely recognized performance benchmark for U.S. stock market activity.
■ It is a United States Department of Commerce leading economic indicator.
■ The S&P 500 does not contain the 500 largest stocks, but the stocks considered are generally
leaders within their industry group.
■ Important industry groups are identified and allocated a representative sample of stock. The four
major groups are industrials, utilities, financial and transportation.
■ It includes stocks from the New York Stock Exchange, the American Stock Exchange and the
NASDAQ.
The S&P 500 value is transmitted to major exchanges every 15 seconds during the trading day. The
exchanges in turn distribute the index values to many quotation vendors. The index is also reported
daily in major financial publications, on radio and on television.
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The Equity Indexed Annuity Interest Crediting
Simple fixed annuities are pretty easy to understand, as far as increasing values are concerned. A fixed annuity variation, indexed annuities are a little different. This is a simple explanation of how the annuity works.
Interest on the equity indexed annuity is credited by applying a participation rate to any increase in the index over an established period of time, or index term. The participation rate, which typically ranges from 60 percent to 100 percent, sets forth the annuitant’s percentage share of any increase in the index. The index term designates the period over which the index interest will be calculated, most commonly five to seven years.
Different Methods of Calculating Interest
In analyzing equity indexed annuities, it is important to understand the relationship between the premium paid and how interest is linked to the index. The interest gained over the index term is a factor that will be of great interest to annuity owners. There are a number of ways to calculate this benefit, the most common of which include point-to-point return, Asian return, highest anniversary look back and annual roll-up.
Typically having the highest participation rates, point -to- point return first compares the value of the index on the contract purchase date with the index value at the end-of-term date. This percent of increase is multiplied by the participation rate to determine the index increase or interest growth. One disadvantage to customers with this system is that over the term, the index might do very well achieving high gains; but could suddenly fall just at the end of the term, consequetly reducing the maximum possible benefit to owners.
Asian return or the average rate return, averages the index over a period immediately preceding the end of the index term, usally the last two or four quarters. Asian return smooths out the peaks and valleys by averaging, thus helping prevent the problem of a sudden drop in value. This method generally has better participation rates than the other methods and often has no cap on return. Point to point and Asian return methods cost less to administer than other methods.
The highest anniversary look back or high watermark references the highest index level achieved at previous anniversaries in calculating the index increase.
The annual reset (ratchet) or lock-in approach allows for annual recalculations. The index is checked annually, and if it has risen, the customer is credited with interest based on the index increase. If the index should fall, the recorded value will be zero, stabilizing the risk factor. This method of calculating index return is very expensive for companies, so they typically include annual changes in participation rates as well as restrictions and caps.
It is important to note that some advertised participation rates for equity indexed annuities are not all they seem. As an example, a few companies offer high participation rates, but their calculations can result in interest crediting that is lower than companies offering lower participation rates.
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Consider this comparison:
Company A offers a 100 percent participation rate on a seven-year term, point-to-point equity indexed annuity with month-end index averaging.
Assume Company B offers a 65 percent rate on a seven-year term, point-to-point with averaging on four quarters of the final year.
Let’s assume the S&P 500 Index increases 15 points at the end of each month, so the index will have increased by 1260 at the end of the seven year term. Lets also assume the EIA was purchased with an issue date index value of 1000 and an initial premium of $100,000.
Company A
The index value for Company A’s equity indexed annuity will be the average of each month’s end index value; (1015+1030+2245+2260 etc. ) ÷ 84 = 1630. The product’s interest earnings at the end of term can then be calculated; $100,000 x (1630-1000) ÷ 0.63 x 100 percent participation rate = $63,000
Company B
The index value for the FEIA will be the average index value at the end of the last four quarters of the
index term; (2260+2215+2170+2125) ÷ 4 = 2192.5. The interest earnings of the FEIA at the end of term can then be calculated; $100,000 x (2192.5-1000) ÷ 1000 = 1.1925 x 65 percent participation rate = $77,512
These examples are for illustration only, and there is no guarantee or warrantee of equal or similar performance in a specific annuity configuration within a specific market environment.
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