Jim Feit is a freelance writer in the greater Palm Beach area. He may be reached at (561) 734-5510 Updated
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February 19, 2004 Last month we discussed the variety of Minimum Earnings Guarantees offered by Equity-Index Annuities to offset the possibility of poor market performance, and to what degree these Guarantees should affect your buying decision.
This month we'll look at one of the most powerful features of Equity-Index Annuities that is entirely absent from stocks, mutual funds, and all other investments that are subject to market risk. I'm speaking of the Annual Reset feature. Afterward, we'll take a look at the range of time periods (known as the Term) offered by Equity-Index annuities, and the role they should play in your thinking.
The Annual Reset feature is present in virtually all equity-based annuities that calculate earnings on a monthly averaging or a 1-year point-to-point basis. The best way to describe this feature is to illustrate its results: how it affects your gains and losses in an Equity-Index Annuity as compared with the ups and downs of your stock market investments.
Suppose, for example, you placed $100,000 in a mutual fund that immediately lost 30% of its value in a sudden market downturn, reducing your holdings to $70,000. Before you could begin to earn even $1.00, that $70,000 of your money still left in the fund would first have to grow all the way back to $100,000 (or grow 43% -- not 30%! That"s why, percentage-wise, it's often easier to sustain a loss than it is to realize a gain!).
With an Equity-Index Annuity, note that you would sustain no loss of principal whatever if the market were to drop, no matter how large the decline. In fact, you would very likely still earn a guaranteed interest rate, whose size would depend on the annuity product you'd have purchased. Furthermore, any earnings already credited to your account would be treated as principal and likewise guaranteed against any risk of market loss.
Here's where the Annual Reset feature comes into the picture. Once each plan year, the value of the market index used as the underlying basis for calculating your earnings is reset to its then present value. What does this mean? It means that, in a market downturn, instead of having to wait to begin earning again until the index value has climbed all the way back to its original value when the downturn began, you'll begin earning the moment the index grows even a fraction of a point above its value on the date of reset. Remember that even though you haven't lost one cent to begin with in your Equity-Index Annuity, the fact is you'll now continue increasing your earnings again much sooner than if you had to wait until the market index had climbed back to the point at which it started losing value.
Example: Suppose the subject market index was at 2000 when it started losing value, and that during a market decline, it had dropped to 1400 on your annuity's reset date. Even if it dropped further, the index would only have to exceed 1400 in value for you to continue earning, instead of having to climb all the way back to 2000.
Just think how much it would have meant to you if, during the last horrendous stock market downturn, your mutual funds or stocks had instead been Equity-Index Annuities equipped with an Annual Reset feature. What a difference that would have made! You would have had no losses to worry about, and you would have been able to continue earning again on the next reset date after the market started its come-back!
Let's take a look at another concern the length of time your money is tied up in an Equity-Index annuity. First of all, note that it never need be completely tied up no matter how long an annuity's term because you would have the ability in every annuity I know of to withdraw annually without penalty anywhere from 5% to 10% of your account value or original contribution, usually after the first year. A small number of annuities do limit total cumulative withdrawals to a stated percentage of contributions, but the vast majority have only an annual 10% limitation on penalty-free withdrawals of your account value. In most cases those are the only Equity-Index Annuities I recommend to my clients.
Then there are those annuities that require your end-of-term payouts to be taken in the form of 5 or more annual installments, which increases their terms by 5 or more years, usually at reduced compensation. Ordinarily I do not recommend these annuities, unless they fit a specific need.
The term of an Equity-Index Annuity can range anywhere from 1 year to as long as 16 years. Frankly, I would not recommend considering an Equity-Index Annuity with a term shorter than 5 years because (1) the annuity would most likely include restrictions on earnings to adequately protect and compensate the insurer, who must guarantee your principal and credited earnings against loss, and (2) the market performs best over a longer period of years, thereby improving your chances of earning an above-average rate of return. Generally speaking, the longer the term the greater the probability of earning well unless, of course, the annuity has features that otherwise restrict its earning ability.
In my surveys of the Equity-Index Annuity field, I have concluded that those annuities offering the best probability of gain, in my opinion, have a term of up to 12 years. I have found that those with terms longer than 12 years do not offer some of the more attractive features and guarantees of their somewhat-shorter-term competitors that most appeal to seniors. However, do not forget that every annuity you might consider must at least be scrutinized for appropriate guarantees as to its minimum cap and participation rates, and that there will be no charges during its entire term, as well as any other features you consider important.
These conclusions and reminder emphasize the need for you to find a trustworthy advisor you can count on to understand your own personal needs and goals, and then have him search for the specific annuities that come closest to satisfying your requirements. It is entirely possible you may have very valid reasons for preferring much shorter terms and be willing to overlook the absence of features you find less important. But if your preference is based solely on a feeling you may have about putting money into any one place for more than just a few years, I urge you to carefully reconsider whether that way of thinking is keeping you from achieving better earnings with no market risk and reasonable liquidity, as well as obtaining certain other features you may find valuable.
In Part 5 we will discuss those other cost-free features of some Equity-Index Annuities that may be well worth considering, such as full penalty-free access to your account value in the event you may require nursing home care or you are diagnosed to have a terminal illness, or in the event of your death, enabling your spouse to become the owner of your annuity and continue it or to receive a payout in full without penalty.
If you have any questions regarding this or prior articles or would like some free information from me purely as a gesture of friendship and good will, without cost or obligation, call me at (561) 734-5510 or send me an E-mail at JIMFEIT@aol.com I'll be glad to help
