Tag: indexing strategy

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Annuities Fixed Index Annuities

Don’t Underestimate the Power of Zero

Every year since my wife and I began investing in fixed index annuities (FIAs) with income riders several years ago, we’ve received annual statements on the anniversary date of each contract. A reconciliation of the beginning- to the end-of-the-contract-year accumulation value is a key component of each statement. This includes additions, or premiums, premium bonuses, interest credits, withdrawals, surrender charges, and income rider charges.

Distinguishing Feature of Fixed Index Annuities

Interest credits and the methodology used to calculate them is a distinguishing feature of FIAs. The amount of interest credited is primarily dependent upon the performance of a stock market index associated with one or more selected indexing strategies during the previous contract year.

There’s generally a cap rate, or preset maximum amount of interest that will be credited for a particular strategy each year. No interest is credited in years where there is negative performance. The current interest rate of a fixed account also affects total interest credited to the extent that this has been selected as part of one’s overall allocation in a particular year.

The annual interest credits on my wife and my FIA contracts have exceeded our income rider charges as a result of the recent performance of the stock market. This has resulted in an increase in the accumulation value and death benefit of our contracts each year, ignoring additions and premium bonuses.

Protection from Stock Market Downturns

Although we’ve experienced, and are delighted by, the annual net increases in the value of our FIA contracts, my wife and I have yet to realize the unique benefit of owning a FIA compared to other types of investments, i.e., protection from inevitable stock market downturns. Unlike direct investments in mutual funds and exchange traded funds that decrease as well as increase in value, FIAs are insulated from market declines. This is sometimes referred to as the “power of zero.”

How is a FIA owner protected from market downturns? As previously stated, no interest is credited to individual indexing strategies in contract years when performance is negative. In other words, index credits will never be less than zero. This is very comforting when this occurs in a negative year, let alone in a prolonged bear market.

To appreciate this, let’s suppose that you invested in an exchange traded fund tied to the S&P 500 that experienced a decline of 20% in one year. You would need to realize a return of 25% just to break even. This turnaround could potentially take several years. On the other hand, the portion of a FIA tied to the same S&P 500 index would be unaffected by the 20% decline. This would simply be a non-event with no interest credited in the contract year in which this occurred.

In the foregoing example, assuming that 100% of your FIA was tied to the S&P 500 index and there were no additions or withdrawals, your end-of-the-contract-year accumulation value would be identical to what it was at the beginning of the year unless your contract includes an income rider. In this case, your contract’s accumulation value would be reduced by the income rider charge, which generally is 0.5% to 1% of the contract’s income account value. Although an income rider charge reduces a contract’s accumulation value, it has no affect on the amount of income distributions you will ultimately receive.

If you’re approaching, or are in, retirement, or if you’re more sensitive to loss than to gain, FIAs may be an appropriate choice for a portion of your investment portfolio. Don’t underestimate the power of zero.

Categories
Annuities Fixed Index Annuities

Simplify Your Financial Life With Fixed Index Annuities

When you get to a certain point in life, there’s a tendency to want to downsize and simplify. That large, two-story house with all of that land becomes a burden. That expensive exotic car that you had to have years ago is no longer necessary.

The same thing applies to investments. Let’s face it, for the average person, the inner workings of most investments are difficult to understand, if not over one’s head. Not to mention how the investment fits into your financial, or retirement income, plan. Add on the risk factor associated with many investments and it can contribute to many sleepless nights.

Welcome fixed index annuities (“FIA’s”). There are basically two flavors – (a) a base product and (b) a base product with an income rider. The key to investment simplification with both is long-term commitment. Per last week’s post, Fixed Index Annuities – A Long-Term Commitment, FIA’s have unique features that can result in lifetime income that exceeds that of other investments provided you have the staying power. If you do, FIA’s are an opportunity to simplify your financial life.

Per last week’s post, staying power was defined as (a) five to ten years, or potentially longer, depending on the surrender charge schedule of the particular FIA, for the base product, or (b) lifetime if you purchase an optional income rider. Assuming that you only invest funds that you’re confident you won’t need for the duration of the surrender charge schedule for the base product, or for your lifetime if you purchase an income rider, this should simplify your financial life going forward.

There are four parts to simplification as it’s applied to FIA’s assuming that the funds used for investment are coming from a traditional diversified investment portfolio:

  1. Reduced risk
  2. Known lifetime income stream beginning at a specified age
  3. Elimination of investment management
  4. Reduction or elimination of investment management fees if applicable

Reduced Risk

Depending upon the types of investments in the portfolio that’s used for your FIA purchase, the risk reduction associated with a FIA can be significant. Please refer to the July 18, 2011 post, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities. Furthermore, the overall risk level of your entire investment portfolio, including your FIA, will generally be reduced as a result of your investment in a FIA.

Known Lifetime Income Stream Beginning at a Specified Age

Unlike a traditional investment portfolio that doesn’t provide for lifetime income, assuming that you purchase an income rider with your FIA, you will have the benefit of a known lifetime income stream beginning at a specified age. In addition, you will have the flexibility to increase your lifetime income to the extent that you defer the start date of your income. Please refer to the January 9, 2012 post, 5 Things You Receive From a Fixed Index Annuity Income Rider – Part 1 of 2.

Elimination of Investment Management

With a traditional investment portfolio, there’s ongoing investment management that’s required, including, but not limited to, investment selection, monitoring, and periodic rebalancing. Whether you do it yourself or hire someone else to do it, investment management is time consuming. With a FIA, there are limited investment choices. These typically include a fixed account and three to five indexing strategies. Once you make your initial investment allocation, although you can typically change it on the anniversary date of your contract, it’s often not necessary to make any changes. Please refer to the August 29, 2011 post, Indexing Strategies – The Key to Fixed Index Annuity Growth.

Reduction or Elimination of Investment Management Fees if Applicable

To the extent that you transfer funds from a professionally managed investment portfolio to purchase a FIA, those funds will no longer be subject to ongoing investment management fees. If you purchase an income rider with your FIA, an income rider charge will be deducted from the accumulation value of your FIA, however, it generally won’t reduce the amount of lifetime income that you will receive from your FIA.

In order to optimize the benefits that you receive from a FIA, it’s important to work with a qualified retirement income planner. Please refer to the August 27, 2012 post, Retirement Income Planner Key to Success When Investing in Fixed Index Annuities.

Looking to downsize or simplify your financial life and have staying power? Take a look at fixed index annuities.

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Annuities Celebration Fixed Index Annuities Retirement Income Planning

Retirement Income Visions Celebrates 3-Year Anniversary!

Thanks to my clients, subscribers, and other readers, Retirement Income Visions™ is celebrating its three-year anniversary. Retirement Income Visions™ has published a weekly post each Monday morning, the theme of which is Innovative Strategies for Creating and Optimizing Retirement Income™.

As stated in the initial post on August 16, 2009, Retirement Income Visions™ Makes Its Debut, the importance of retirement income planning as a separate and distinct discipline from traditional retirement planning was magnified during the October, 2007 – March, 2009 stock market decline. Just ask anyone who retired just prior to, or during, this period that didn’t have a retirement income plan in place when he/she retired.

With increasing life expectancies, record-low interest rates, traditional pension plans going by the wayside, soaring health and long-term care costs, and the potential for inflation, retirement income planning is no longer an option. It has become a necessity for anyone who wants to ensure that he/she will have sufficient income to meet his/her expenses for the duration of retirement. Recognizing this fact, The American College launched its Retirement Income Certified Professional™ (RICP™) program earlier this year in which I was one of the first enrollees.

Since its inception, Retirement Income Visions™ has used a themed approach, with several weeks of posts focusing on a relevant retirement income planning strategy. This year was no exception. The weekly posts, together with the customized Glossary of Terms, which currently includes definitions of 137 terms to assist in the understanding of technical subject matter, has contributed to a growing body of knowledge in the relatively new retirement income planning profession.

While the first two years of Retirement Income Visions™ presented a variety of retirement income planning strategies, fixed index annuities, or “FIA’s,” have been the sole focus of virtually every weekly post for the past 13 months. Continuing a theme that began on July 11, 2011 during the second year of publication with Shelter a Portion of Your Portfolio From the Next Stock Market Freefall, the inner workings of FIA’s, including their unique benefits as a retirement income planning solution, has been discussed in detail. As a result, Retirement Income Visions™ has become an authoritative source of information on this important and timely topic.

Although FIA’s has been the theme of almost every post for over a year, the posts have been organized by a number of sub-themes. Following the July 11, 2011 post, the introduction to the FIA strategy continued with the next five posts, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities (July 18, 2011), Limit Your Losses to Zero (July 25, 2011), Do You Want to Limit Your Potential Gains? (August 1, 2011), When is the Best Time to Invest in Indexed Annuities? (August 8, 2011), and How Does Your Fixed Index Annuity Grow? (August 22, 2011).

The next twelve posts, beginning with the August 29, 2011 post, Indexing Strategies – The Key to Fixed Index Annuity Growth, through the November 14, 2011 post, How to Get Interest Credited to Your Fixed Index Annuity When the Market Declines, presented a thorough discussion of the various traditional fixed index annuity indexing strategies. This included an introduction to, and comparison of, the following indexing methods: annual point-to-point, monthly point-to-point, monthly average, trigger indexing, inverse performance trigger indexing, as well as the fixed account that’s included as one of the strategy choices by virtually every FIA.

Moving beyond the base product, the subject of the next nine posts was an introduction to the income rider that’s offered by many FIA’s. The income, or guaranteed minimum withdrawal benefit (“GMWB”), rider is the mechanism for providing guaranteed (subject to the claims-paying ability of individual life insurance companies) lifetime income with a flexible start date that is essential to so many retirement income plans. This kicked off with the enlightening December 5, 2011 and December 12, 2011 posts, No Pension? Create Your Own and Add an Income Rider to Your Fixed Index Annuity to Create a Retirement Paycheck. The introduction to income rider series also included two two-part series, Your Fixed Index Annuity Income Rider – What You Don’t Receive (December 19, 2011 and December 26, 2011) and 5 Things You Receive From a Fixed Index Annuity Income Rider (January 9, 2012 and January 16, 2012).

Following two posts introducing fixed index annuity income calculation variables on January 23, 2012 and January 30, 2012 (10 Fixed Index Annuity Income Calculation Variables and Contractual vs. Situation Fixed Index Annuity Income Calculation Variables), a five-part series ensued revolving around a topic often misunderstood by the general public — premium bonuses. The posts in this series included 8 Questions to Ask Yourself When Analyzing Premium Bonuses (February 6, 2012), What’s a Reasonable Premium Bonus Percentage? (February 13, 2012), How Will a Premium Bonus Affect a Fixed Index Annuity’s Value? (February 20, 2012), How Will Withdrawals Affect Your Premium Bonus? (February 27, 2012), and How Will a Premium Bonus Affect Your Fixed Index Annuity Income Distribution? (March 5, 2012).

The next five posts delved into the inner workings behind the variables and interaction of variables behind the calculation of income withdrawal amounts from FIA income riders. This included the following posts: Income Account Value vs. Accumulation Value – What’s the Difference? (March 19, 2012), How is Your Fixed Index Annuity’s Income Account Value Calculated? (April 2, 2012), How Much Income Will You Receive From Your Fixed Index Annuity? (April 9, 2012), and a two-part series, Don’t Be Fooled by Interest Rates – It’s a Package Deal (April 16, 2012 and April 23, 2012).

When Should You Begin Your Lifetime Retirement Payout? was the subject of a two-part series (May 7, 2012 and May 14, 2012) followed by another timing question, When Should You Begin Investing in Income Rider Fixed Index Annuities? (May 21, 2012).

The May 28, 2012 through June 18, 2012 four-part series, Fixed Index Annuity Income Rider Similarities to Social Security, was a well-received and timely topic. This was followed by a second five-part comparison series beginning on June 25, 2012 and continuing through July 23, 2012, FIA’s With Income Riders vs. DIA’s: Which is Right for You?

The last two weeks’ posts have addressed the topic of valuation of a FIA’s income rider stream. This included the July 30, 2012 post, What is the Real Value of Your Fixed Index Annuity, and the August 6, 2012 post, Why Isn’t the Value of Your Income Stream Shown on Your Fixed Index Annuity Statement?.

As I did in my August 9, 2010 and August 15, 2011 “anniversary” posts, I would like to conclude this post by thanking all of my readers for taking the time to read Retirement Income Visions™. Once again, a special thanks to my clients and non-clients, alike, who continue to give me tremendous and much-appreciated feedback and inspiration. Last, but not least, thank you to Nira, my incredible wife, for her enduring support of my blog writing and other professional activities.

Categories
Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 2 of 5

Retirement Income Center - Puzzle

As stated in Part 1 of this post, while fixed index annuities (“FIAs”) with income riders can be used to provide guaranteed (subject to the claims paying ability of individual life insurance companies) lifetime income beginning at a future date, they aren’t the only fixed income annuity game in town. Of the 12 features offered by FIA’s with an income rider that are listed in Part 1, three are offered by deferred income annuities (“DIAs”), four are applicable on a limited basis, and the remaining five aren’t applicable. The last group is the subject of this post.

The following is a list of the five features offered by FIAs that aren’t applicable to DIAs:

  1. Potential doubling of income amount to cover nursing home expense
  2. Investment value in addition to future income stream
  3. Protection from loss of principal
  4. Potential for increase in investment value
  5. Potential matching of percentage of investment amounts by financial institution

Potential Doubling of Income Amount to Cover Nursing Home Expense

The first feature, potential doubling of income amount to cover nursing home expense, isn’t a standard feature of FIAs with income riders. Of the 184 FIAs that currently offer guaranteed minimum withdrawal benefits (“GMWBs”), or income riders, 53, or less than one-third, include some type of long-term care benefit. When present, the amount of the benefit compared to the standard income amount, as well as qualification for this benefit, varies.

Investment Value in Addition to Future Income Stream

While DIAs and FIAs with income riders both offer the ideal retirement income feature of guaranteed (subject to the claims paying ability of individual life insurance companies) tax-deferred lifetime income, only FIAs also have a traditional investment value associated with them. Psychologically, this is comforting to investors who are uneasy with exchanging a lump sum of money “only” for an income stream who don’t understand the concept that the present value of the future income stream is an investment just like a brokerage account or any other investment asset.

Protection From Loss of Principal

Protection from loss of principal as well as features #4 and #5 are driven by feature #3, i.e., investment value in addition to a future income stream. The investment, or accumulation, value of FIAs, as it’s better known, will never decrease as a result of investment performance. It will either increase or remain unchanged on an annual or biennial basis, depending upon particular stock indexing strategies chosen. In the event of negative performance of a particular strategy, it will remain unchanged.

Potential for Increase of Investment Value

The investment, or accumulation, value of a FIA can increase to the extent that it’s allocated to one or more of the following three investment choices:

  1. Fixed account
  2. Traditional indexing method when the performance of the chosen index is positive
  3. Inverse performance trigger when the performance of the associated index is negative

The last choice, inverse performance trigger, isn’t a standard FIA indexing crediting option. Of the 253 FIAs on the market today, there are only 12 products available from two life insurance companies that offer this innovative strategy.

Potential Matching of Percentage of Investment Amount by Investment Institution

As previously stated, unlike DIAs that don’t have a traditional investment value associated with them, FIAs offer this feature. In addition, of the 253 FIAs available today, 130, or approximately one-half, have a percentage matching, or premium bonus, as it’s more commonly known, feature. A premium bonus is a fixed percentage of the investment in a FIA that’s added by some life insurance companies to the FIAs accumulation value during the first contract year and, sometimes, subsequent contract years, for a specified number of years.

As discussed in previous posts, the availability of this feature, as well as the bonus percentage amount when offered, shouldn’t be relied upon in and of itself to determine the suitability of a particular FIA in a given situation.

Categories
Annuities Fixed Index Annuities

Contract Date – The Driver of Fixed Index Annuity Performance

Retirement Income Center

Last week’s post began a discussion about the second way that fixed index annuities grow in addition to a contract’s defined minimum guarantees – indexing strategies. It pointed out that there are actually two choices that you need to make when selecting a particular indexing strategy: (1) Stock market index and (2) Indexing method. Stock market indexes, including how they work and the different types that are typically available when working with fixed indexed annuities, was the subject of last week’s post.

What is the purpose of an indexing method? An indexing method, together with a particular stock market index, determines the amount of interest that is credited to the value of a fixed index annuity on the contract anniversary date each year. Interest crediting is flexible and will vary for each fixed index annuity contract based on several factors.

No matter which stock market index(es) and indexing method(s) is (are) chosen, interest crediting is first, and foremost, driven by the contract date. This is the date on which the contract is effective. The measurement date for all indexing strategies begins on this date.

Every indexing strategy uses a contract year. In the first year, this period begins on the contract date and ends on the day before the contract anniversary date. In subsequent years, the ending date is the same, however, the contract year begins on the contract anniversary date.

Suppose that you applied for a fixed index annuity for your IRA last month using funds that were rolled over from your dormant 401(k) plan and your fixed index annuity is issued with a September 6, 2011 contract date. The measurement period for calculation of interest crediting during your first contract year will begin on September 6, 2011 and will end on September 5, 2012. Your second contract year, or measurement period, will begin on September 6, 2012 and will end on September 5, 2013, and so forth.

Since each contract year for each fixed index annuity contract is determined by the contract date, there are 365 (366 for fixed index annuity contracts issued in leap years once every four years) possible measuring periods. Forgetting about choices of stock market indexes and indexing methods, given the sheer number of measuring periods, no single indexing method will result in the highest interest crediting in every situation. The performance of a particular indexing method will be different if the contract year begins on September 6th vs. if it begins on February 23rd, and, furthermore, will vary from year to year.

While generalizations can, and are often made, about the performance of various types of indexing methods during different types of markets, e.g., bull vs. bear, it’s important to keep in mind that no one can predict the change in a particular stock market index from one date to the same date a year later, let alone predict the individual monthly changes during a particular year that is required for working with certain indexing methods.

In summary, fixed index annuity interest crediting is determined on an annual basis by the performance of one or more chosen stock market indexes and indexing methods based on the original contract date. Given the fact that there are 365 or 366 possible measuring periods and typically several choices of indexing strategies, interest crediting amounts will generally be different for each contract issued for each fixed index annuity product.