Equity-Indexed Annuities: Dont Take The Bait

Anyone whos been fishing knows that one of the keys to catching the big one is having the right kind of bait. Many in the financial services industry understand this truth all to well and theyve come up with the perfect enticement to hook unsuspecting investors. Its called the equity-indexed annuity (EIA) and chances are, if youve visited a traditional advisor recently, youve heard its compelling pitch. Guarding Your Wealth is a nationally syndicated weekly personal finance column written by Jeffrey D. Voudrie, CFP. Mr. Voudrie is the President of Legacy Planning Group, a private wealth management firm that employs sophisticated proprietary strategies designed to protect and grow its clients' investments. Please visit our website, www.guardingyourwealth.com to read past articles in our archive.

August 23, 2004 -- Anyone whos been fishing knows that one of the keys to catching the big one is having the right kind of bait. Many in the financial services industry understand this truth all to well and theyve come up with the perfect enticement to hook unsuspecting investors. Its called the equity-indexed annuity (EIA) and chances are, if youve visited a traditional advisor recently, youve heard its compelling pitch.

Of course, for bait to be effective, it has to be something the intended target will happily swallow. Insurance companies have created a wonderful presentation that uses smoke and mirrors to give investors the impression that equity-indexed annuities are the answer to all their financial problems. But the reality doesnt live up to the promises.

The marketers of financial products know that one thing older investors want is simplicity. Seniors dont want to have to wade through a lengthy sales pitch or be overwhelmed by financial techno-babble. Salespeople know if they can offer an apparently simple solution to investors, their chances of making the sale are greatly increased.

Equity-indexed annuities are presented as being a simple way to have risk-free growth of your nest egg. They promise a guaranteed minimum return, while keeping the growth potential of the market. They promise that you cant lose any money and many even sweeten the pot with first year bonuses and riders that allow you to access your money for nursing home care and other early withdrawals. It all sounds so good and its so simple. But is it, really?

The answer is no. Equity-indexed annuities are actually very complicated.

Lets take a closer look at how complicated equity-indexed annuities really are by starting with their chief claim, the guaranteed minimum return. Most investors have the impression that on a year-to-year basis they receive the guaranteed minimum return or the market return, whichever is higher.

But thats not true. You either get the indexed return or guaranteed minimum return for the life of the contract, whichever is greater. So if its a 15 year contract, at the end of the 15 years, the insurance company looks back and figures whether youd have earned more, at the guaranteed rate or the market return for the entire 15 years. So suddenly the guaranteed minimum isnt too impressive.

To make matters more confusing, on some contracts you dont get the guaranteed minimum return on all of the money you put in. For instance, some pay a 3% guaranteed minimum return on just 80% of your initial investment. So in essence, youre really guaranteed only 2.4%. That doesnt sound as good, does it? When the list average on a short term Certificate of Deposit is around 5%, why would you want to lock in a 2.4% rate for 15 years?

How the index return is calculated is much more complicated. Youd think that the insurance company would just tie your market return to an established index, like the S&P 500, and mirror its return. Unfortunately, its not that simple. There are over 40 different methods in which these rates are determined and they vary widely from company to company. The explanations for these calculations are so complex, theres no way the average consumer could even hope to understand them. Even professionals find these methods extremely confusing.

Even if you could understand how your index return is calculated, it doesnt matter because the insurance companies can change how they calculate it from year to year. They can also modify the maximums, minimums, participation rates, asset fees, other charges at their own discretion. And theres nothing you can do about it.

Why would insurance companies do this? That part is very simple. Insurance companies understand the importance of keeping their flexibility and control, because they know that the markets and interest rate environments can change dramatically over the life of your contract. They put these safety valves in place so they make sure they make a profit. Of course, that can reduce how much you make.

If insurance companies put a high priority on maintaining their flexibility and control, shouldnt you? Be smart and dont take the bait purveyors of equity-indexed annuities are offering. Use your head and dont get sucked into a deal that, like many others, you may soon live to regret.

If you would like me to answer specific questions about your financial situation, feel free to email me at e-mail protected from spam bots. I respond to readers questions on an almost daily basis and would be happy to answer yours.

Mr. Voudrie is a Certified Financial Planner, nationally syndicated newspaper columnist and President of Legacy Planning Group, Inc., a Private Wealth Management Firm in Johnson City, TN. He can be reached toll-free at 1-877-827-1463 or at e-mail protected from spam bots

Looking for an energetic expert who is passionate about financial and wealth management? Mr. Voudrie is an excellent speaker who will excite and inspire your audience. Mr. Voudrie is available for a limited number of speaking engagements, television appearances and radio talk shows. For booking information, contact Christine Lavender at (877) 827-1463 or email e-mail protected from spam bots.

Related Articles can be found at www.guardingyourwealth.com under the Guarding Your Wealth Article Archive:

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