Fixed index vs. variable annuities


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Fixed index vs. variable annuities

  1. 1. Fixed Index vs. Variable Annuities by The Annuity Reporter
  2. 2. Lifetime income riders on annuity products are becomingincreasingly more popular and relevant given today’seconomic climate and the sheer number of peopleapproaching retirement. I don’t know the exact percentagebut the majority of newly issued fixed index and variableannuity contracts carry a provision for guaranteed lifetimeincome.The reason? Consumers are happy to know that a check isguaranteed to arrive each month during retirementregardless of how the market performs. Anyone who investsin the stock market has been burned at one point or another.For the average investor, it happens more frequently as mostpeople don’t have the time or expertise to apply technicalanalysis to retirement planning. In reality, many pros havetrouble as well.When we’re talking about legitimate guaranteed incomeproducts, consumers need a viable source of qualityinformation. Why? Potential consumers are likely to begiven only one option from most advisors that recommendthese products. That doesn’t mean you’ll get a bad deal butit does mean there might be a better deal out there.Let’s get down to business…There are currently two major players in this market,companies who offer fixed index annuities and companieswho offer variable annuities. The product you ultimatelychoose will depend entirely on personal preferences.
  3. 3. Here’s how variable annuities workSince a variable annuity gives the opportunity for full marketparticipation, you will be invested in a combination of mutualfunds and bonds for the most part. In exchange for fullgrowth potential, you will also carry the risk of loss ofprinciple. You know how that works. That’s where the GLWBcomes in. It doesn’t matter if the market tanks, a minimumlevel of income is guaranteed and that level of income canincrease if the market does well over time.Variable annuities carry additional fees to account for theinsurance protection provided. When charges for companyexpenses, asset management and the income rider aretallied you’ll be looking at no less than 3.5% in today’senvironment.As for the guaranteed lifetime withdrawal benefits, the levelused to calculate income payments increases annually. It istypical to see annual increases, or roll-ups as they are called,to hover in the neighborhood of 5%-6%.When it comes time to take income, you will receive incomefrom the GLWB balance or the account balance, whichever isgreater. Payout rates will start around 4% at age 60 andusually increase by a half percent for every five or ten yearsyou wait to take income. Downward adjustments to thepayout rate will be applied for joint contracts.Remember, this is a general analysis of what’s available inthe current market. Each variable annuity contract will be
  4. 4. slightly different.Here’s how index annuities workWith a fixed index annuity you get partial marketparticipation in exchange for a principal guarantee. Yourupside growth is limited but there is no downside. Let’s notforget that this is essentially a fixed annuity where theinsurance company buys a portfolio of bonds and credits theaccount with the interest earned on that portfolio. With anindex annuity the growth is based on purchasing indexoptions with the annual interest earned from the bondportfolio. So growth in an index annuity contract is subjectto an external market index but the principal is stuck inbonds so no loss of principal can occur. Please refer to theFixed Index Annuity Report for more details on how thisworks.Index annuities use various means to price each contractincluding cap rate, participation rates and a spread. This isalso discussed in further detail in the Fixed Index AnnuityReport. As far as fees go, income riders usually cost about .75% annually on most contracts.The income benefit also is guaranteed to increase annuallywith index annuities. That’s where the major benefits toindex annuities start; with the annual roll-up on theguaranteed lifetime withdrawal benefit. These rates arecurrently running at 7%-8%.Of course with this product type, you’ll also be planning on
  5. 5. taking income at some point. It works the same here as withvariable products. Income will be based on a percentage ofthe account value or guaranteed lifetime withdrawal benefit,whichever is greater. The benefits continue here with payoutrates generally starting about .5% higher than variableannuities.Why are Index annuities more competitive?Yes, there is no comparison between index and variableannuities for purposes of guaranteed future income. Thereasoning is simple.Variable annuities are backed by an unstable asset base thatis constantly fluctuating. This makes it difficult for anactuary to price. Because of the volatile asset base, futureprojections come with a great deal of variance. As a result,guarantees need to priced very conservatively.Index annuities carry high-grade bonds for an asset base.Future projection are then much easier to price because theprincipal investment is exposed to little or no risk. In turn,the company can offer guaranteed income rates accordingtraditional variables like principle, mortality and interestrates. Insurance companies have nailed that calculation forlonger than any of us has been around. When an unstablevariable is added to the equation, the guarantees take a hit.How To Choose Which ProductMy advice is to always take the highest guarantee available.Honestly, that’s what annuities are all about. But that means
  6. 6. everyone would always take the fixed index annuity if giventhe option. I certainly don’t think that should be the case.There will always be people who want to be active in themarket. Because variable annuities offer unlimited growthpotential, the risk of loss is worthwhile to a certain class ofinvestor.