It’s been eight years since the catastrophic crash of 2008 and since then, the market has been slowly recovering. Do you really want to spend your golden years waiting for the next shoe to drop?
Most mutual fund investments including variable annuities that claim to be “professionally managed” do NOT have principal protection measures in place. These investments CAN lose you money, which is why a handful of the largest insurance companies designed a new kind of annuity.
Pick your index
In response to a large number of people retiring without pensions, the insurance industry created a new annuity a little over 21 years ago. The first one came out in the mid-90s under the name Equity-Indexed Annuity. Now, variations on this annuity have been called the FIA or EIA or even the hybrid annuity, but what it does hasn’t changed:
Your principal earns interest in a market index such as the Dow Jones Industrial Average or the S&P 500, you choose, but here’s the cool part:
- If the market gains, you gain.
- If the market goes down, you stay where you are.
Sound too good to be true? The Financial Industry Regulatory Authority (FINRA) explains it this way: “The guaranteed minimum return is typically at least 87.5 percent of the premium paid at 1 to 3 percent interest.”[1]
This means these investments can offer excellent principal protection, but the crediting methods used to calculate returns can be complicated, which is why there are some things you want to understand before signing up.
Set your timeline
Your principal is the amount of money that you put into an investment.
- When you are working, your goal is to GROW your principal.
- Once you hit retirement, your goal is to PROTECT your principal.
If you are ten or more years away from retirement, you want to start putting some protection measures in place. Like a bank CD, the indexed annuity arrives at its protection measures by asking investors to make a certain time commitment. The best ones we’ve seen ask for somewhere between four and 10 years, and like a CD, if you take out more than 10 percent of the fund, you’ll feel the pain of a penalty.
This penalty makes sense if you think about it from the insurance company’s point of view: in order to give you that principal protection, long-term investment strategies are needed. This makes the FIA an ideal investment for IRA’s with Required Minimum Distributions that come due at age 701/2. Once you establish your timeline, you can earn market-linked gains while waiting to take this money out.
Understands your gains
Next, make sure you understand how your gains will be calculated and what the maximum gain will be. In order to keep your money safe, FIAs have us a combination of indexing features that calculate the spread or put caps or limits on the gains. Financial salespeople who earn commissions selling these products can sometimes paint an overly enthusiastic picture when it comes to the potential for returns.
These are the different indexing methods used to calculate gains:
- annual reset
- high water mark
- point to point
These crediting methods determine the amount of interest you will gain, but rather than using the actual value of an index on a certain date, some FIAs use daily or monthly averages. These averages also influence the amount of interest you will gain, so ask your financial professional which method he or she would recommend in your situation. Historically speaking, the FIA has an assumed rate of return that ranges between 5 and 8 percent.
Remember this message
Protect your principal! Protect your principal! Why? Because once you are retired, it can be even more difficult to recover from a loss than it is to earn a return. When you consider that the FIA can give you this protection along with returns upwards of 5 percent, then you have a deal worth shouting about.
