Equity Indexed Annuities Safe And Competitive

One possible college planning strategy can be using tax deferred annuities in repositioning assets with the use of annuities. College Selection Strategy can provide the necessary expertise for the proper selection in college planning based upon a family's individual circumstance.

Equity Indexed Annuities are fixed annuities not variable annuities that are "linked to stock market indexes" but your money is not at risk. Here are some characteristics for basic understanding of how annuities work with additional information on equity indexed annuities.

 An annuity is a contract issued by an insurance company. It is a unique financial product that provides tax deferral of interest. There are no capital gains recognized until the annuity is accessed through withdrawals or annuitization. Annuities provide various planning objectives, the primary one being for retirement/distribution purposes.

Annuities can be broken down into two functions,  the accumulation phase and the distribution phase.
 

The Accumulation Phase

Features

  • During the accumulation phase, the fund grows tax deferred, it does not grow tax free. If the annuity was not purchased as part of a qualified retirement program such as an IRA, 401(k), TSA, or 457 plan, income taxes are paid on the earnings when money is ultimately paid out. If the annuity is part of a qualified plan the entire fund is subject to income taxes as it is withdrawn.

  • Surrender charges for early withdrawals. Most offer partial withdrawals free of surrender charges.

  • If you withdraw money from your annuity before age 59 1/2  it is called a premature distribution and is subject to an additional 10% IRS penalty.

  • If a premature death should occur, the accumulated funds within the annuity are transferred to the named beneficiary, avoiding probate costs.

  • Annuities can vary by payment mode and are available as single premium (purchased with one-time payment) or flexible premium (purchased with recurring periodic payments). They also vary by timing of the annuity income and may be available as a deferred annuity (which means that annuity income payments are deferred until later) or as an immediate annuity (which means that annuity income starts immediately).

  • For fixed and equity indexed annuities there is safety of principal and earnings.

  • Variable products are subject to mortality and expense charges and administrative fees not typically found with other investments.

Traditional fixed annuities have an interest rate that is paid by the insurance carrier based upon their criteria, sometimes guaranteed for a specified number of years. Indexed Annuities are fixed annuities but are commonly referred to as equity indexed annuities or indexed annuities.

Fixed Annuities

In a fixed annuity, the insurance carrier:

  • Guarantees a minimum interest rate of return which is specified in the contract, and at no time may the current or renewal interest rate fall below it

  • Declares a current rate of interest for a specified time period. Once the time expires the company will set a new rate which may be higher or lower than the original rate.

  • Guarantees the principal, contracts differ but generally the guarantee returns the original principal plus a minimum interest rate by the selected maturity period.

  Equity Indexed Annuities

An Equity-Indexed Annuity (EIA) has interest rates that are linked to growth in the equity market as measured by an index such as the S&P 500, Russell 2000, NASDAQ 100, and so forth. The EIA owner enjoys the upside potential of equities but is not exposed to downside risk. Subject to fixed minimum guarantees, the value of an EIA can only increase due to market growth  it will never decline due to market movement.

There are many variations in product design. No two of the EIAs are exactly alike, and some are very different from each other. There are various "moving parts" with an EIA, advantages / disadvantages are related to the results in the index movement, up or down. For example, some will perform better in bear markets, some better in bull markets.

There are two basic elements, one is the crediting methodology used and two, the moving parts that can change according to the pricing of "options".

Some credit methodologies are:

  • Annual Reset -  Also known as the annual ratchet design, the annual reset design resets the starting index point annually. It also credits index increases (interest) annually and compounds annually.
  • Point-to-Point -  The point-to-point design measures the change in the index from the start of the term to the end of the term.
  • Monthly Averaging - Takes a starting point, then each month subject to a monthly "cap" calculates the monthly movement point, then averages the twelve months and divides it into the starting point for any possible gain.
  • Daily Averaging - Uses the starting point, calculates where the index ends each trading day of the index, averages the daily averages and divides by the starting point for any possible gain.

 The primary moving parts are:

  • Participation Rates - The carrier according to the option pricing market selects a participation rate that the contract carrier is guaranteed until the rate is changed. The period of time of the guarantee often times depends the carrier's crediting methodology, how frequent they post their calculations. For example, few carriers do it daily, some do it monthly, still others have various ways.
  • Cap Rates -  These are placed on some types of EIA's to limit the upside potential but the trade off is usually a higher participation rate. For example, the cap rate may 11% but participation rate may be  75%. Another carrier might offer a 15% cap rate with a 60% participation rate. The option pricing environment drives the carrier's selections as well as their own financial objectives.

Withdrawal

  • Withdrawals may be made at any time. However, the withdrawal may be subject surrender charges and if done before age there will be a 10% IRS penalty. Some contracts allow an annual 10% withdrawal free of surrender charges.

  • The owner may pre-authorize a systematic periodic withdrawal plan. The owner of the contract instructs the company to withdraw a percentage or a level dollar amount from the contract on a monthly, quarterly, semiannual, or annual basis.

The Distribution Phase -  Better for Retirement than Funding College

      As part of the distribution phase, the owner has two options, he or she can withdraw money (either in a lump sum or elect a systematic withdrawal plan) or annuitize (purchase an annuity pay out plan).

  • Annuitization -  When the owner annuitizes the funds he or she purchases an annuity pay out plan. In a Fixed and in an Equity Indexed Annuity the owner purchases a monthly income that will be paid to him or her until death. It is a guaranteed income that will not change

Annuity Pay Out Plans

  • Life Only - Periodic monthly payments to an annuitant for the duration of his or her lifetime and then ceases. It is for a lifetime, the annuitant cannot outlive the payments. The  payments are determined at the time of purchase and are based on age and gender using a life expectancy table.
  • 10 years certain Payments will be made for at least ten years, regardless if the annuitant lives for the entire ten years. If the annuitant dies during the ten-year period the remainder of the ten-year payments will be made to a beneficiary. If the annuitant lives longer than ten years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than life only.
  • Life with 20 years certain Payments will be made for at least twenty years, regardless if the annuitant lives for the entire twenty years. If the annuitant dies during the twenty-year period the remainder of the twenty-year payments will be made to a beneficiary. If the annuitant lives longer than twenty years he or she will continue to receive payments for his or her lifetime. The guaranteed monthly payments will be less than Life with 10 years certain.
  • Income Benefit  Riders - These are riders that actually calculate a separate account from the guaranteed account and the accumulation crediting account. The riders guarantee a basic rate of return, say 7.5% for each year. Upon distribution through the rider, you are limited to a fixed amount  each year, for example 5%. These riders can be very attractive when your objective is an income you cannot outlive.

WARNING: You must have these riders explained to you properly as some will present them as an 7.5% guaranteed return as in the above example. While that is part of the story, you can only "get to" 5% each year (unless they have an increasing component which many do) NOT  the entire balance. So, you can see the 7.5% is really an accumulation "starting point" for the specified annual withdrawals, not a guaranteed accumulation amount where you can take the entire balance at once.

These riders are a result of the disadvantages of annuitization and "freezing" you withdrawal status and not being able to adjust moving forward for several factors, the biggest inflation.

Additional information from Wikipedia.


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