Author Topic: Equity-Indexed Annuity  (Read 8767 times)

Denarius

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Equity-Indexed Annuity
« on: May 29, 2014, 04:02:44 PM »
I am interested in hearing your feedback regarding Equity-Indexed Annuities, or any annuities really. Is this a part of your FIRE strategy? Would you recommend these products to your peers or do you think these are not appropriate as part of your retirement strategy.


MDM

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Re: Equity-Indexed Annuity
« Reply #1 on: May 29, 2014, 06:53:34 PM »
"No" to Equity-Indexed Annuities.  Read http://forum.mrmoneymustache.com/investor-alley/a-new-start-with-everest-wealth-management-qa-with-the-management/ (and all the links) to get some idea why.

See also the articles linked in https://www.bogleheads.org/wiki/Category:Annuities.
« Last Edit: November 30, 2018, 01:45:47 PM by MDM »

Nords

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Re: Equity-Indexed Annuity
« Reply #2 on: May 29, 2014, 10:54:46 PM »
I am interested in hearing your feedback regarding Equity-Indexed Annuities, or any annuities really. Is this a part of your FIRE strategy? Would you recommend these products to your peers or do you think these are not appropriate as part of your retirement strategy.
No.  I'd never recommend them to anybody.

They're essentially sold through fear-marketing tactics to help investors sleep better at night.  You're paying huge fees (and giving up most of the index's returns) in exchange for someone else guaranteeing that you won't outlive your investment.  Of course that guarantee is only backed to the extent of the limits of the state insurance commissioner's liability.

If you're interested in learning more (and, if you think you want an EIA, then you should be interested in learning more) then read "Index Annuities:  A Suitable Approach" by Marrion & Olsen.  It's reportedly used to train financial sale staff advisors.  Pay close attention to the way that the indexes and the payouts are calculated.  If that's "suitable" then I'll stick to index mutual funds.

I got my free copy of the book after I said unkind things about EIAs in this post:
http://the-military-guide.com/2013/11/27/fixing-the-fixed-indexed-annuity/
After reading the book, I stand by my comments and the links.

If you think EIAs are still the way to go, then consider Steve Vernon's advice:
http://the-military-guide.com/2012/05/23/retirement-planning-just-tell-me-what-to-do/
You can do better on your own, but this system will help you sleep better at night.

clifp

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Re: Equity-Indexed Annuity
« Reply #3 on: May 29, 2014, 11:25:59 PM »
Nord 's advice is excellent and if you are interested in learning more read his links.

If you'd like a more fun suggestion.  Rather than buying an EIA I'd suggest the following. Take 90% of what you were planning on spending (say $100,000) and buy a 10 year US Gov TIPS bond this will guarantee that  your money won't lose to inflation.

The remaining 10% go wild with $10K, strippers, 30 year old scotch, Rolling Stones ticket, Super Bowl, first class cruise, whatever floats your boat.

At the end of the 10 years financially you'll be about as well off and you instead of the annuity salesman will have had fun.

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #4 on: May 30, 2014, 07:44:17 AM »
I am interested in hearing your feedback regarding Equity-Indexed Annuities, or any annuities really. Is this a part of your FIRE strategy? Would you recommend these products to your peers or do you think these are not appropriate as part of your retirement strategy.

stay away!  There are a whole mess of different annuities and life policies based on flavours of the same <strike> scam </strike> insurance company approach, with almost always front loaded fees and high transaction costs/ low or zero liquidity.

the deal works like this. Most people think they will not die unusually early. Or even on time. Statistical data tells me if I have a large group of people buying my annuity/universal life policy etc, some will die early. But people all think they will live longer than average, so more than should will fear outliving investments or savings. Its the standard and real benefit of a life insurance policy. Ok.

I now take that insurance 'value' and combine it with similar statistical analysis of the market. I take all the upside if the market goes up,  and insure the downside.  I charge fees to do that.  There is no free lunch.

So avoid those things. Save 2 exceptions, IMHO

1. Pure term life insurance.  If you have big liabilities,  like you're 34 and have a young family, mortgage, go online and buy some term life. If you are healthy, it'll cost hardly anything. Get enough to cover liabilities until kids are old enough and stash big enough. This is a real product that does offer real value to the purchaser who needs it (not someone FIRE already tho')

2. A % of your stash after FIRE and at probably 60 or 65 could be used to buy fixed standard annuities that provide a guaranteed income stream until you die, unrelated to the market completely. You can get inflation adjusted or not, single or married. This is like reverse life insurance.  Because some people will die, the insurance company can pay more than say, TIPS yield, and invest the money meantime. You get a higher yield,  they take all the risk wrt market, but if you die you'll loose the money. However,  if you are FIRE and have a big stash anyhow, do you really care? Again,  available competitively online.



All the

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #5 on: May 30, 2014, 07:50:17 AM »
(Sorry, tablet not letting me scroll!)

All the....  other stuff is insurance companies and financial vampires trying to suck fees and commissions out of your hard earned stash. They will involk wierd estate tax crap, graphs showing how great in previous year X it would have been, blah blah blah.

Run Will Robinson, Run!

hodedofome

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Re: Equity-Indexed Annuity
« Reply #6 on: May 30, 2014, 09:25:37 AM »
Life insurance can be a good idea if you are a really high net worth individual and concerned about estate taxes after you die. But most of us aren't in a position to worry about that yet. I don't know all the details but there's a way to buy life insurance in your later years and pass all that money tax free to your kids. If you don't have a large estate (like $5-10 mil plus), this isn't anything to worry about.

What Mr. Mark said about buying term life early in life and a standard (not exotic) annuity later on in life is a good idea if it helps you sleep at night.

Nords

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Re: Equity-Indexed Annuity
« Reply #7 on: May 30, 2014, 09:40:24 AM »
There's a lot of financial wisdom here, but my head is still stuck on Clif's mental image of strippers with the Rolling Stones...

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #8 on: May 30, 2014, 10:43:22 AM »
There's a lot of financial wisdom here, but my head is still stuck on Clif's mental image of strippers with the Rolling Stones...

+1

Isn't that what you get all the time in Hawaii anyhow? ;-)

Nords

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Re: Equity-Indexed Annuity
« Reply #9 on: May 30, 2014, 11:27:42 AM »
There's a lot of financial wisdom here, but my head is still stuck on Clif's mental image of strippers with the Rolling Stones...

+1

Isn't that what you get all the time in Hawaii anyhow? ;-)
... on longboards.

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #10 on: May 30, 2014, 12:57:36 PM »
Nords,

how do you see the utility of real annuities for say, 55+ FIRE folks? Especially if you're genetically and physically healthy, that seems a winner if we're talking, say a few 100k as as baseline firewall of income.

especially I guess for folks less comfortable with " the scary casino stock market"  and thus tempted by the lure of the insurance salesmen and other parasites?

interested on your take. I find we are increasingly visited by annuity sales people here, pushing products to get google hits with spam, while there is wheat within the chaff perhaps.

Nords

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Re: Equity-Indexed Annuity
« Reply #11 on: May 30, 2014, 11:34:09 PM »
Nords,

how do you see the utility of real annuities for say, 55+ FIRE folks? Especially if you're genetically and physically healthy, that seems a winner if we're talking, say a few 100k as as baseline firewall of income.

especially I guess for folks less comfortable with " the scary casino stock market"  and thus tempted by the lure of the insurance salesmen and other parasites?

interested on your take. I find we are increasingly visited by annuity sales people here, pushing products to get google hits with spam, while there is wheat within the chaff perhaps.
I'm a fan of annuities (especially single-premium immediate annuities) for longevity insurance.  I'm not a fan of EIAs unless, as Clif says, they come with Rolling Stones tickets and strippers.  Assuming that either act has entertainment value when we're in our 100s...

However the only annuity that most Americans may ever need is Social Security.  The only annuity that military retirees will ever need is their military pension (perhaps with survivor benefits).  A federal civil-service pension is also a pretty nice annuity, as is one purchased from the federal/military Thrift Savings Plan.  It's always good to have an annuity backed by a government with taxation authority.

I've heard of real estate investors who feel that their rental income is the equivalent of an annuity.  I'm skeptical of this stance because a real SPIA will deposit money in your checking account whether or not you're taking care of your assets.  An SPIA also doesn't depend on your cognition.  Real estate is a popular investment in Hawaii, but I've seen way too many elderly landlords who (for various reasons) have stopped taking care of their properties or who are being neglected by their property managers. 

Another possible annuity equivalent could be a TIPS ladder or a TIPS fund or I bonds.  Those aren't strictly annuities but they might cost less and they might provide sufficient longevity insurance... provided that the federal govt keeps selling TIPS and I bonds. 

People with no annuitized pension income should buy enough SPIAs to cover a bare-bones budget.  (This will raise a retirement calculator's success rate from 90% to 100%.)  It probably involves buying them at different times and from different insurers so that the state insurance commissioner has you covered in case of (extremely rare) insolvency.  One researcher recommends starting ER without any annuity income, but if your portfolio drops below a certain value then you would convert most of the remainder to annuitized income.  (See Figure 9 on page 10 of http://www.schulmerichandassoc.com/Modern_Portfolio_Decumulation.pdf).  I believe that Jim Otar recommends different asset allocations to annuities depending on the portfolio withdrawal rate.

Moshe Milevsky spent most of the 1990s trashing annuities for their high fees and deceptive marketing.  When he wrote "Are You A Stock Or A Bond?" in 2008, however, he felt that SPIAs had regained their value through lower fees and better marketing.  Anyone contemplating an annuity should read a library copy of this book-- at the very least the chapters on annuities.  Most annuity buyers can get a competitive quote through Vanguard or Berkshire Hathaway (or at least use those sites as a negotiating tool).  For those with a TSP account, quotes can be run on the TSP website.

Here's other thoughtful posts on SPIAs and asset allocation:
http://wpfau.blogspot.com/2012/02/safety-first-goals-based-approach-to.html?spref=tw (Wade Pfau)
http://retireearlyhomepage.com/annuity_costs.html (ER pioneer John Greaney)
http://retireearlyhomepage.com/annuity_costs_2.html
http://lifeinvestmentseverything.blogspot.com/2012/01/rolling-your-own.html (create your own EIA, written by our very own Brewer)
http://the-military-guide.com/2011/03/23/asset-allocation-considerations-for-a-military-pension-part-2/
http://the-military-guide.com/2010/12/30/tailor-your-investments-to-your-military-pay-and-your-pension/


Edit:  Hunh, I may have written a blog post here.  Please critique the content so that I can make sure I've covered the major issues...
« Last Edit: May 30, 2014, 11:36:25 PM by Nords »

clifp

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Re: Equity-Indexed Annuity
« Reply #12 on: May 31, 2014, 12:17:33 AM »
One type of annuity that I am seriously considering when interest rates return to more normal level is a deferred SPIA also known as longevity insurance.
These typical are bought when you are younger 40s and 50s and don't start paying any benefit until you are much old typically 75 but older is possible.

For me it is a less concern with market risk, and more concern with me falling victim to dementia and being conned out of my money by some shyster.  I'm hoping the person at least looks like Anna Nicole/a stripper, but it could be almost anybody. I'd to have done all this financial planning only to find out at age 75 or 80 all my money was gone.  While it is possible that some shyster could sell the annuity and collect money it is much harder than simply getting the old person to write them a check.  It is also a big reason why I intend to not take SS until 70.  I am trying to make my retirement as bullet proof as possible.    Both Nords and I are dealing with our surviving parent a suffering from dementia much worse in Nord's case.

Least anybody think it is just old codger who fall in love with  young bimbos, my grandmother fell in love with the handsome 40 year old trust officer.  After he was done my family lost about $1 million out of $2 million estate.

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #13 on: May 31, 2014, 01:40:01 PM »
Nords,

thank you - great links.

I noticed one graph, showing effective cost of purchase of $1 of annuitised income per year. Once you get ( males hit crossover point earlier)  to about age 55, you can assure a SWR of > 4% until you die. In fact, at 85 your effective swr using an annuity is well over 10%. Younger than about 55 - 60 you are better with the market and those firecalc SWRs, but don't fear end of life - a few annuities will insure your dotage far cheaper than an equity portfolio.

Those too worried about their stash running out of money in old age should keep that in mind. By age 65 or so you will able to buy a swr much greater than 4%, and even over 10% once you hit really old age. And I don't belive social security will dissappear either.

TreeTired

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Re: Equity-Indexed Annuity
« Reply #14 on: May 31, 2014, 01:49:51 PM »
A friend and neighbor of mine was selling annuities back in the early 2000s and he described his product as guaranteeing equity index returns with no risk to initial invested principal, along with a guaranteed minimum return of 6% or something like that.    I was very skeptical, but asked to see the prospectus because I wanted to help out a friend.   I have an MBA and worked in the finance industry and I couldn't quite figure the darn thing out, even while reading the prospectus, so I declined.

Having said all that,  I have read that some of the terms and guaranteed returns that were offered on these types of annuities back then are no longer available because they were too rich for the buyers of the contracts and too expensive for the companies that sold them!    So there may have been something "too good to be true" in there but I was either too skeptical or just too dumb to figure it out.

kyleaaa

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Re: Equity-Indexed Annuity
« Reply #15 on: June 01, 2014, 03:54:40 PM »
SOME equity indexed annuities can be intelligently used SOME of the time, especially if you're looking for leverage but what to minimize the possibility of getting wiped out. You pay dearly for the downside protection, though.  Overall, not recommended, and never for the commonly-sold reason of getting stock market-like returns without the downside.

clifp

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Re: Equity-Indexed Annuity
« Reply #16 on: June 01, 2014, 05:10:45 PM »
A friend and neighbor of mine was selling annuities back in the early 2000s and he described his product as guaranteeing equity index returns with no risk to initial invested principal, along with a guaranteed minimum return of 6% or something like that.    I was very skeptical, but asked to see the prospectus because I wanted to help out a friend.   I have an MBA and worked in the finance industry and I couldn't quite figure the darn thing out, even while reading the prospectus, so I declined.

Having said all that,  I have read that some of the terms and guaranteed returns that were offered on these types of annuities back then are no longer available because they were too rich for the buyers of the contracts and too expensive for the companies that sold them!    So there may have been something "too good to be true" in there but I was either too skeptical or just too dumb to figure it out.

Moshe Milevsky addressed this in the most recent edition of Are you a stock or a bond?.  I am a bit fuzzy on the details, but IRRC it had to do with mis-pricing the risk that interest rates would fall dramatically.  There was element of truth in my post about strippers and rolling stones.  EIA can be replicated (Brewer has made detailed posts on this on his blog) with putting the bulk of the money into a fixed income investment like a zero coupon bonds.  Then using the remaining money to purchase an option or future on an index.  The options and futures don't include dividends which is why EIA don't inlcude them either. When insurance companies  sold the annuities they assumed they could find 5-8% fixed income security in future years instead of 2-5% they are looking at today.

FYI, the guaranteed minimum return of 6%, is not actually money you will see in the cash value of investment, but rather in the separate account that is only useful if you are going to convert the policy into a life annuity.  Much of the guarantee return stems from a simple fact the longer you delay collecting the annuity the less years the insurance company is going to have to pay you, so they can afford to give you min. increase.

brewer12345

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Re: Equity-Indexed Annuity
« Reply #17 on: June 01, 2014, 07:13:10 PM »
SOME equity indexed annuities can be intelligently used SOME of the time, especially if you're looking for leverage but what to minimize the possibility of getting wiped out. You pay dearly for the downside protection, though.  Overall, not recommended, and never for the commonly-sold reason of getting stock market-like returns without the downside.

I am going to call "shenanigans" on this one.  It is so easy to replicate an EIA in a brokerage account at a fraction of the cost an insurer would charge you, I see no reason to buy this product ever.

Nords

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Re: Equity-Indexed Annuity
« Reply #18 on: June 01, 2014, 08:18:18 PM »
SOME equity indexed annuities can be intelligently used SOME of the time, especially if you're looking for leverage but what to minimize the possibility of getting wiped out. You pay dearly for the downside protection, though.  Overall, not recommended, and never for the commonly-sold reason of getting stock market-like returns without the downside.
I am going to call "shenanigans" on this one.  It is so easy to replicate an EIA in a brokerage account at a fraction of the cost an insurer would charge you, I see no reason to buy this product ever.
We've heard the urban legend for years that annuities are good for some situations.  Is that for high-liability professions like doctors & lawyers who might want to shield their assets from malpractice litigation, or for high-risk marriages where one spouse's annuity income is not subject to marital-property division?  Hedge-fund owners who want to shield some of their assets from civil litigation?

Once you filter out all the people who've been duped into buying an EIA, who really needs to have an insurance company wrap one up in a pretty package and sell it to them for a commission?

Mr Mark

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Re: Equity-Indexed Annuity
« Reply #19 on: June 07, 2014, 08:10:00 PM »
In general with any deal, step back and figure out where the real value is coming from. How can a company guarantee a yield greater than market? this seems impossible.

But the real value is of course not everyone will beat the market. Given a pool of investors of known age, an insurance company can "know"  how many of those people they promised to pay will instead die earlier. They can work out the delta, offer some to us as above market return (a swr well above 4%  for example), and take the rest as profit. 

It is a highly competitive market.  So do due diligence and you will get real value if you need a baseline retirement income (maybe for some reason you don't get social security,  or that isn't enough),  but there is no free lunch. You can get above market returns using an annuity,  as long as you outlive the pool.

if you don't,  the insurance company collects, and the great thing is you don't care.

livingthedream

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Re: Equity-Indexed Annuity
« Reply #20 on: June 08, 2014, 09:33:39 AM »
My understanding is that the earnings are taxed as ordinary income. So say goodbye to low rates you could get for capital gains and dividends. 

Clyde

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Re: Equity-Indexed Annuity
« Reply #21 on: February 24, 2015, 08:38:36 PM »
Non-fixed annuities are only good for people who are willing to take risks. Having an annuity will surely cost you but there is a possibility of growing your money while it is still in an annuity. However, there is no guarantee if you would get an amount higher than your principal money or not. But the main use of this is that you will have a steady stream of income at a later time when you might need your money.

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Re: Equity-Indexed Annuity
« Reply #22 on: February 24, 2015, 08:42:49 PM »
I put my retired father into a fixed insurance annuity upon retirement.  He was quite clear that the acceptable level of risk for him was *zero*, "It's everything I worked all my life for!"  The return is under 4 percent but it is "enough" to supplement SS and is RMD compliant.

I'm still trying to persuade him the best place for surplus from his RMD is municipal bonds.  Very low risk, and better return than his annuity on post-tax basis.