Equity Indexed annuity- best investment around?
Is the equity indexed annuity the best investment in today’s economic environment? Let’s analyze the most important investment attributes.
Yield: Most equity indexed annuities pay a bonus of 6-10% on the initial amount invested. After that, the returns are tied to the performance of an index like the S&P 500 or the Dow Jones Industrial Average. In years where the indexes perform well, the annuity can perform very well. In years where the averages go down, the annuity will return zero instead of losing money like stock mutual funds. Also, the annuity has a fixed interest rate component which usually pays 3-4% which is substantially higher than CDs and money market funds.
Safety: The equity indexed annuity is guaranteed by the full faith and claims paying ability of the issuing life insurance company. It is important to select a company with a high rating and in many cases these companies will be backed by billions of dollars of assets and reserves from a company that may be over 100 years old. Life insurance companies are analyzed by four rating agencies and each agency assigns a letter rating to the company. The review includes a review of the company’s balance sheet, operating performance and business profile. It is important to choose a company with A, A+ or A++ rating as these are the safest companies. Each state has an insurance commissioner that regulates insurance companies and monitors their financial performance. When an investment is made in an equity indexed annuity, the life insurance company is required by law to set aside a minimum of $1.04 for every $1 of principal that is invested. Many companies have a $1.50 to $1 ratio of reserves to deposits. By contrast a bank is only required to have between 5-15% of a deposit in reserve. Insurance companies control more assets than the banks and oil companies in the world combined. They have very conservative investment strategies which help keep them safe and liquid.
Taxes: Taxes on an equity indexed annuity are not paid until a withdrawal is made. This allows the premium and interest to grow tax deferred. This gives you triple compounding because you earn interest on the principal, interest on your interest, and interest on the money that would normally be paid in taxes. Also, the owner controls when the taxes will be paid by advantageous timing of their withdrawals. Another important tax factor is the exclusion ratio. When an annuity is annuitized, part of the monthly payment is considered a return of principal and is not taxable.
This keeps a substantial portion of your monthly payment off your tax return because only a portion of your payment is taxable interest. This lowers your overall income in computing taxes on social security benefits.
Liquidity: Equity indexed annuities are intended to be long term investments. They usually have decreasing surrender charges of 10% or more that may run as long as 10 to 14 years. However, most programs allow a 10% withdrawal on an annual basis with no penalties. These surrender charges have a positive effect on insurance company safety because it is unlikely there would a run on the company because of the charges that would be incurred to withdraw the money.
Fees: When money is invested in an equity indexed annuity, the whole amount is immediately credited and there are no sales charges deducted as in other types of investments. There are usually no annual administrative fees and if the policy is held to the end of the surrender period, there are no charges to withdraw the money. Charges are made only if more than 10% is withdrawn in a year or the policy is surrendered before the surrender period is over.
In summary, the equity indexed annuity is close to the perfect investment. It provides safety, growth, tax deferral, low or no fees and limited liquidity. It should be considered for almost every type of retirement plan.