Ortiz Method #10: Indexed Annuities

24 Apr Ortiz Method #10: Indexed Annuities

Annuities may not be known for their flexibility. I mean it is a contract with an insurance company so that isn’t much of a surprise that liquidity is not their area of strength. What annuities lack in flexibility they make up for with variety. There are countless different annuities out there with varying rates of return and stipulations, but they are generally broken down into a few different categories. In this article, we will be discussing Indexed Annuities. They are also referred to as equity-indexed or fixed-indexed annuities.

Annuities are sometimes used as a way for investors to avoid the stock market. Well, not with indexed annuities. Indexed annuities were made with the opposite intention, to let annuity holders participate in market gains while still being able to protect yourself from the downturns in the market. They work by paying a participation rate based on the performance of a specific market index. The S&P 500 for example. This sounds fantastic in theory, but of course, it cannot be that simple. It is important to make sure not only that indexed annuities are right for you, but also if they do fit your portfolio that you are picking the one that best suits your financial goals and needs. The best place to start is by understanding how they work.

Annuities were originally designed to compete with CD returns, not stock market returns. Indexed annuities were designed to earn a modest amount of interest that you can turn into an income stream in the future. Indexed annuities are not all bad, but they do get very complicated. But broken down, it is easy to see if and how an indexed annuity will work for you. As previously stated, indexed annuities have a participation rate that is based on the performance of a market index. But how is this performance calculated? Participation rates are calculated either on the year-over-year gain in the index, or the average monthly gain over a 12-month period. Again, you do not get to participate in all this gain with indexed annuities. This is because of the ‘participation rate’. The participation rate limits the annuities participation in the percentage of growth of the index. For instance, if the index your annuity is linked to has a year-over-year growth of 10% but your participation rate is 50% your yield is then 5%. Participation rates can be as low as 25% and as high as 100%. You should also be aware that the industry average is between 80%-90% and is usually subject to change after the first year. This brings us to yield caps. Most indexed annuities will also include a yield cap, which is another limitation to the amount of money that is accredited to your accumulation account. If you have a yield cap of 3% then that is where you cease participation in market gains of that index. These yield caps range from 1% to 4%. On the flip side, there are also guarantees on the low end of your market participation rates as well. The minimum rate of returns is for the times when the market has a down year. The minimum rate could be 0% to 2% guaranteed rate of return on your money if your index performs poorly over the life of your contract. In summary, make sure that you ask your agent or advisor about yield caps, minimum rates of return, and participation rates, as they will dictate how much money comes back to you.

There are also certain intervals on your annuity timeline where the insurer will adjust the value of the account to any gain that occurred during that time frame. This could be done year-over-year, or it could be done point-over-point. Your principle is typically protected. You can lose money in these types of annuities if you withdraw money from your account before you are 59 1/2 or if you surrender the annuity too soon. If you withdraw early you could get hit with portfolio draining taxes. And if you surrender the annuity too soon you are looking at hefty surrender charges. It would be wise to avoid annuities if you are going to need that money in the next few years.

Annuities also have these provisions called riders that are used to ensure certain aspects that are important to you are included in the annuity contract. Make sure you check out our blog next week where we will discuss these in greater detail and how they will affect your money.

When it comes to indexed annuities there are a lot of things that you want to remember and consider. From the actual participation that you will have in the market to the performance of the annuity with and without the riders that you may want. Remember, you want to make your choices based on what the annuity will do, not what it could do. If you have questions about indexed annuities or annuities in general, contact us at Ortiz World Wealth and get a consultation on your financial status today. And remember Plan Smarter Live Better.


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