Dollars & Sense - Some facts about index annuities

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Some facts about index annuities

By Bob Moeller
WEAC Member Benefits

October 2006

Financial Planning Seminars
Achieving Financial Independence

Welcome back! In one of my articles last year I was critical of index annuities. I received an irate letter from a salesman who informed me I didn’t understand index annuities. He accused me of looking for the negatives in this product (which I freely admit I do; that’s my job). He acknowledged that some index annuities are not good products but maintained he was an expert after years of selling and he sold good products. He even volunteered to help me write a correcting article. Much as I might need help with my writing, I decided just to ask him to send me facts about his products, which, to his credit, he did.

So, below is my letter to him which represents my analysis of one of his index annuities, specifically, the Allianz MasterDex. Later, I realized I had failed to mention that the product had a provision which provided that once you had received a value at the end of the year which was higher than your previous high value, you were assured of getting at least this value when the contract terminated. This is a positive provision.

• • •

Dear Sir: I am going to state what I interpret to be the facts of the Allianz MasterDex statement of understanding. I am asking that you correct me if I am incorrect.

You are investing in an index annuity.
If you complete the seven-year term and surrender the policy, you cannot lose money.
If you do not complete the seven-year term, you will pay a withdrawal penalty as high as 10% and no lower than 4% if you withdraw your money.
You may get an increase in value each year based on the monthly change in your index.Your increase each month can be limited at the sole discretion of Allianz to as low as 1%. Any decreases are unlimited. That means if the index goes up 2% per month for the first 11 months and your limit is 1%, you will end up at the end of the 11th month with an increase of 11% even though the index went up 22%. If in the 12th month the index goes down 12%, you will end up with no net gain for that year at all even though the index itself was up 10% for the year.While not likely, over seven years, the index could go up a net of 70% and you could get nothing.
If you have a gain at the end of the seven years and you withdraw your funds, you will pay regular income tax rates on the gains, not capital gains rates.
If you should have a gain in your account and die before withdrawing the funds, your heirs will get no step-up in cost basis which would save them income taxes.
As an alternative, if you actually invested in an index fund you give up the “can’t lose money” guarantee but get all the gains.You also get any dividends credited to the index.You also pay long-term capital gains rates on any long-term gains. If you die while owning the index, your heirs will get a step up in cost basis for tax purposes, which will save them income taxes.

While I don’t have data for sevenyear periods, statistics show that the S&P 500 index has NEVER gone down over any 10-year period.

Again, I am asking that you correct any errors in the above.

Finally, as you probably are aware, the financial industry is undergoing a period of self-examination regarding the degree to which various practitioners accept the fiduciary standard with their clients. If one of my members asked you to take fiduciary responsibility in selling them this product,would you?

• • •

I have not heard back from the salesman. Need I mention again that highly regarded, large insurance companies like Northwestern Mutual refuse to sell these?

Do I still feel index annuities are not good deals? Absolutely.

Consumer Reports Magazine (see quote in left column) says that both index and variable annuities are generally bad investments.True.

This article was about indexed annuities. As an example of the excessively high costs in variable annuities, in the Wall Street Journal on September 11, I reviewed the ING Golden Select Premium Plus Max 7 (wow, what a title). This fund has many investment choices and almost every one has annual fees in excess of 3% which is ridiculous! Even their index fund fees are 2.8%, compared to Fidelity’s 0.1%. Fees 28 times higher!

I frequently receive messages from members who are confused by the complexity of investments. I believe you can simplify it greatly. One of the first rules is to just say to yourself,“ I will not buy any investment products from any life insurance company.” Period. No, you will not miss out on any wonderful opportunities.

Posted November 11, 2006