Beware of equity indexed annuities, says Forbes Investment Guide. If your goal is to protect principal, you give up too much for that protection in an equity indexed annuity; there are better ways to do it, according to a Forbes article by William P. Barrett entitled “Protection Racket.”
Salesmen often pitch the product by saying: If the market goes up you win, and if it goes down you win because you don’t lose. The first prong is false; if the market goes up, you lose because of the costs and lost upside potential.
The upside is typically limited by “performance caps” of 8% of the price appreciation of the reference index and 0% of dividends, which historically have generated about 40% of equity returns. In addition, that “up to 8%” is often further reduced by a “participation rate.” Thus, investors often must take multiple haircuts and wind up with, at best, 60% of up to 8% of price appreciation – or a max of 4.8%. When the S&P 500 goes up 23% like it did last year, that’s a heavy price to pay.
On top of that, the issuer makes a “market value adjustment,” a complex calculation that usually reduces the cash value of the account. If all of this does not sufficiently benefit the insurance company issuer, the fine print contains a provision allowing it to change its initial promises, according to the article.
To make investors hold still for this once they understand what is happening, there is a hefty surrender penalty to get out of the contract in the first 6 to 10 years.
“We’ve said it before, and we’re saying it again: Whatever your station in life, indexed annuities are in all likelihood a lousy investment. If preserving capital is your main objective, there are much cheaper and simpler ways to do it.”
“Indexed annuities are the latest in a long line of sizzle things,” one financial planner explained. “All they do is link two things and add a layer of costs.”
State regulators have sued or issued warnings about deceptive sales of indexed annuities.
Last year, a federal jury found that Allianz Life Insurance Co. of North America, the nation’s top indexed annuity seller and a unit of Allianz Se, misrepresented one product by promising a 10% “bonus” to hundreds of thousands of buyers. The bonus was illusory and could not be cashed, according to the article.
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