Retirement Watch

The case for fixed-indexed annuities

Despite their negative rep, new products have qualities that make them suitable for retirees

Dec 9, 2012 @ 12:01 am

By Doug Wolff

So far this year, somewhere around $34 billion worth of fixed-indexed annuities have found their way into Americans' retirement portfolios. Though that's well below the $80 billion in variable annuities purchased, the gap is closing. And there is good reason to think it will close further.

Today's fixed-indexed annuities offer a value proposition that makes them highly suitable for many pre- and post-retirement investors, specifically a benefit suite that combines income predictability and growth potential with downside protection of principal.

Yet many financial advisers continue to overlook them. Why? Because there's still a good deal of baggage left over from past products. Mention them to certain advisers — some really good ones, in fact — and you'll hear all about lengthy surrender periods, high commissions and bonuses, and complexity at the expense of the consumer.

Though these annuities have a negative reputation in some circles, a new generation is hitting the market. A number of today's fixed-indexed annuities are much more user-friendly than their predecessors, with shorter surrender periods, less complexity, fair consumer-friendly commissions and greater access to optional lifetime-income guarantees.

DISPELLING MYTHS

These next-generation annuities deserve consideration for a broad range of retirement portfolios. We suggest that financial advisers, working amid a historic shakeout in the variable annuity market, take a fresh look. With that goal, we want to clear up some myths:

Fixed-indexed annuities include hidden fees and charges. Not true. Like traditional fixed annuities, fixed-indexed annuities include a guaranteed credited-rate option, for which the company invests the consumer's payments, deducts an interest spread and determines the interest to be credited to the consumer's account value. Fixed-indexed annuities also offer one or more index-linked crediting buckets to which consumers can allocate. If optional value-added riders are chosen, an explicit fee for each rider is disclosed and deducted from the account value.

They are better for advisers than clients. It's debatable whether this was ever true, but what we can say is that a group of consumer-friendly products is entering the market. They are designed and priced specifically to serve recently retired or soon-to-be-retired people, and they have characteristics that mirror many variable annuities.

They have high surrender charges. Fixed-indexed annuities are insurance products designed for the long term and, like many annuity contracts, they have surrender charges. These diminish, of course, and in time go away entirely. A number have surrender periods of five or seven years, and some charge less for surrenders than in the past. Many contracts include waivers of surrender charges for critical situations such as confinement to a nursing home or diagnosis of a terminal illness — a feature not found in other financial products, such as stocks, bonds and most mutual funds.

They allow the insurance company to profit from equity market gains at the expense of the customer. Doubtless, this myth has its roots in an erroneous belief that “crediting limits” produce a windfall benefit to the provider if market performance exceeds index-crediting caps. On the contrary, a consumer's premium payments are put to use on the consumer's behalf: Via a hedging mechanism, the provider sells off potential excess market-related gains in exchange for protection against market downturns. The more attractive risk profile allows providers to offer better benefits to consumers at a lower cost.

They can't keep up with inflation. These are low-risk retirement income solutions that pay a fixed rate of interest, which, by itself, may not keep up with inflation. But they also provide the opportunity to benefit from a part of financial market gains without taking on the risk of market losses, a combination that, over time, may increase the client's account value faster than the rate of inflation.

Bottom line: In this post-crash environment, many investors' views on risk and principal protection are shifting conservative. At the same time, variable annuity capacity has contracted because of market volatility and the extended low-interest-rate environment. This combination makes the principal stability, reasonable growth potential and guaranteed income options offered by fixed-indexed annuities increasingly attractive to anyone looking for predictable income in retirement. There are good reasons sales are on the rise.

Doug Wolff is president of Security Benefit Life Insurance Co.

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