‘Buyer Beware’ of Index Annuities

By Bob Moeller, CFP,
WEAC's Member Benefits Manager

April 2001

Financial Planning Seminars
Achieving Financial Independence

One of the things I always try to do in this position is test out various programs our members might run into, just so I can relate to questions or problems that come up later. A few years ago, for example, I signed up for a home equity line of credit I didn’t need just so I could evaluate it.

Recently, I found an insert in the morning newspaper announcing a free seminar covering such issues as how to keep the government from taxing almost all of your IRA, and how to make sure your children get some benefit from it in their inheritance. So it was only natural that I decided I had to go. Besides, it featured a “nationally known speaker.” I realized it was my shortcoming that I had never heard of him.

About 30 people showed up, and there were no refreshments! The nationally known speaker asked that there be no questions until the end, and then disappeared after his part, never to be seen again. He was essentially setting things up for a local company that markets various products. There was no information on the products in any detail in the room. The idea was that in order to avoid a disaster with your IRA withdrawals, you should set up an individual “free” appointment. At the appointment, your IRA would be analyzed for free – and perhaps, either with or separate from your IRA, you might explore a risk-free stock index annuity. I mean who doesn’t want to participate in the stock market if they can do it with no risk?

So let’s look at the concept. It is a fairly recent development, and is being offered by many institutions. First, a simple example offered by many credit unions in Wisconsin. You choose a two-year CD. Instead of an interest rate, you get half of the growth in the S&P Stock Index over the two years. So, if it goes up 20% in two years, you get 10%, or approximately 5% a year. If it goes up 50% in two years, you get 25%. On the other hand, if it goes down (until 2000, many people didn’t think that happened), you do not suffer a loss. Rather, you get back your original amount. No risk!

Is it a good deal? Well, at least your terms are clear and it is easy to understand. But you give up a lot of possible gain in order to be sure you can’t lose principal. I would not be willing to give up so much of the possible gain, but some might find it attractive.
Soon, altered products were offered, such as you might get 40% of the stock market increase, or 3% interest, whichever is greater. Here you know you will make something. But still the terms are fairly clear.

Now enter the life insurance industry with Index annuities. This is the product being sold through the seminar I attended. Not sold right there, you understand, but through a “free” private consultation. So I called. I asked for a prospectus, a mistake since this is not a mutual fund offering. I was sent two sales brochures, one from F&G Insurance, and one from Allianz (Life USA). I called and asked for a sample policy, which would give me the real terms and how it worked.

Looking at the F&G brochure, which was 20 pages long, I could figure out almost nothing. A separate brochure does inform me that:

• There is a 10% withdrawal penalty in the first three years, which declines 1% a year to the 10th year, when it is 3%. It is not clear what happens after the 10th year.
  
• You get only half of the average increase – repeat average increase – in the S&P 500 stock index, and then they deduct an additional 2½% off that figure per their example. For example, if the index goes up 12% (a good year), the average amount it was up was 6%. Deduct 2½%, and you get 3½%. So, in a good year, you get a lousy return. How about a tremendous year, when the market goes up 25%? If the average increase for each day of the year was only 12½%, you get that minus 2½%, or 10%. And this was a tremendous year! True, if the market goes down, you suffer no loss. In fact if every year of your first 10 years is a disaster, (this has never happened), you will get a small increase in value. Is it a good deal? I haven’t signed up.
  

The second product (Allianz, Life USA) was similar, but with some important differences. You get only the average increase for the year, but there is a 12% maximum amount you can get for the first five years. After five years, the cap can be set lower according to the company’s whims, but it won’t be less than 3%. Of course, if you don’t like the cap amount, you can take your money out, except there is a 15% withdrawal penalty for the first five years then declining to 2.22% in the 11th year. Finally, there are borrowing provisions, annuity provisions, etc., that are not particularly good.

Final evaluation? Be very very careful before you enter into an index annuity. Almost certainly, it is not a good deal for you. Certainly, the two above are not good deals.

If you have one and want it evaluated, or are considering one and want it evaluated, send the detailed terms or a copy of the policy itself to me at WEAC, P.O. Box 8003, Madison WI 53708. Neither I nor WEAC have any connection with any companies that sell index annuities.

Posted April 2001