Image Credit: Christophe Vorlet
By Jason Zweig | Dec. 15, 2017 10:59 am ET
With the U.S. stock market brushing all-time highs again this week, many investors are chasing further gains — and some are trying to truncate potential losses.
You can do that with what’s called a fixed indexed annuity, a cross between an insurance contract and a market-tracking index fund. Such a product typically offers a minimal guaranteed annual return along with an assurance of no losses in years when the stock market drops. In exchange, it delivers less than the full gain on stocks in years when the market goes up. It may also assure retirement income and some protection against inflation to boot.
Unfortunately, these annuities are often marketed so aggressively that you could be fooled into thinking you can get stock-like returns at no risk. You can’t.
According to Limra, a research group funded by the insurance industry, sales of fixed indexed annuities totaled $42.9 billion for the first nine months of 2017. That was down 9% from the same period in 2016, largely because new regulations from the Department of Labor chilled sales to retirement investors, says Todd Giesing, annuity research director at Limra’s Secure Retirement Institute. Limra projects sales will rebound to roughly $60 billion next year as parts of the regulation are put on hold.
About 54% of fixed annuities sold in the third quarter didn’t come with a guaranteed stream of income in retirement, says Mr. Giesing. Their purchasers are seeking “protected growth,” or the potential for appreciation while sidestepping the stock market’s losses, he says. Fewer than half the buyers chose to lock in guaranteed lifelong income, even though two-thirds of sales were to holders of Individual Retirement Accounts or similar long-term saving plans.
If you buy a fixed indexed annuity, you have to lock up your money, often for seven to 10 years and sometimes longer. If you need your capital before then, your withdrawal will usually be subject to a surrender charge, or penalty, that can run up to or even exceed 10% of the account’s value. (After one year, you may be able to make small withdrawals penalty-free.)
Another risk is opportunity cost: the additional money you could have made by not buying the fixed indexed annuity in the first place.
While the annuity puts a floor under your potential losses, it also puts a ceiling on your potential gains. Over time, the stock market goes up more — and more often — than it goes down.
Therefore, “the longer your time horizon, the more likely it becomes that the stock market will outperform the annuity,” says Wade Pfau, professor of retirement income at the American College of Financial Services in Bryn Mawr, Pa.
The many people who buy these products as a kind of stock-market play for cowards have the wrong idea.
“Fixed indexed annuities are not an alternative way of investing in stocks,” says John Olsen, an annuity consultant in St. Louis. “They have completely different risk and reward components. They are an alternative to other fixed-dollar investments, such as certificates of deposit or Treasury bills.”
Often, however, these products are marketed as if they were every investor’s dream come true, offering most of the upside of the stock market with no downside. The marketing message is: You’ll make plenty of money if stocks go up, while losing nothing if they go down.
To try proving that dubious argument, some insurance companies and their agents use charts showing hypothetical, not actual, returns.
That’s a problem for at least two reasons. First, a specific annuity contract may not have been in force for the full period shown in the chart. And the percentage of stock-market gains the product earned may have varied over time, even though charts like these tend to show a constant participation rate. In the real world, such rates may reset as often as monthly.
As a result, these hypothetical charts imply that someone owning the annuity would have continuously earned the rate in place at the end of the period. Meanwhile, on Planet Earth, the product didn’t even exist for the whole period, and the rate at which it could have tracked the stock market fluctuated over time. Mr. Olsen says any chart based on such assumptions is “nonsense.”
Furthermore, most of these displays pit the performance of the annuity against the S&P 500 without including dividends, which have averaged about 2% in recent decades.
A fixed indexed annuity might make sense if you crave certainty, can’t bear the thought of losing money and don’t mind tying it up for a decade or so to earn a middling, but assured, return for the rest of your life. It makes no sense at all as a way to keep pace with the stock market at no risk. That’s a combination that exists only in fairy tales.
Source: The Wall Street Journal, http://on.wsj.com/2kxbqeV
