April 10, 2015 Admin | April 10, 2015 What is an indexed annuity? How are they sold to unsuspecting investors? Why should you avoid them?
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An annuity is a “guaranteed” return on an investment. A much lower return than you’d get if invested in other places. This allows the investor who has your money to invest it in a market that will return more so they can make some money and give you a smaller percent. An indexed annuity is an annuity that is linked to an index, for example the S&P 500 index. The returns on your annuity will never be less than 0 if the index is down one year but it will also not raise above a cap. So if the index annuity cap is 3% but the index raises 8% in one year the investment firm takes the difference, 5%. If you had invested directly in the index you’d get a much higher return. Indexed Annuities can also have a lot more rules and fees baked into the contract. Overall they are usually much more costly and a hassle. They are a tool to make money for investment firms, not for you. A good place to read up on all the rules (fees) of indexed annutites is here. https://www.fidelity.com/viewpoints/retirement/considering-indexed-annuities
Indexed annuities are advertised being guaranteed to never lose money when markets are down and having the potential to make money when markets are up. To the unsuspecting investor, this seems like a great, low risk option, but when you look into the fine print, you would find that when markets are up, your returns will be capped. For example, if your returns were 10% for the year, stated yearly fees are 2.5%, and your earnings are capped at 9%, you would only receive a total of 6.5% for the year (capped earnings of 9% – fees of 2.5%). You would have been much better off investing directly in the index fund because you could have captured that additional 3.5% –of your money! On the other hand, owning the index fund directly would also mean that you would have lost money in the years the market was down, but over a long period of time, your average return will be much higher from investing this way than they would have been with the annuity.
An index annuity is a way for the life insurance industry to try and get uninformed investors to give them more money. Index annuities sound like index funds and are the selling point for them, they follow an index such as the S&P 500 but cost a great deal more due to the annuity aspect of them. They lock up your money and charge higher fees and give you a small fixed return.
The answers continue to get better by the day. I have nothing to add. Well done!