The Truth About Indexed Annuities

Recently, Dateline NBC exposed unfair sales practices by Insurance Companies offering Indexed Annuities. Cited as especially troubling was that agents failed to warn clients of hefty surrender charges should they desire to retrieve their funds early. As a financial services professional, I would like to explain how Indexed Annuities work and how they can help you to build your retirement savings.

Most people I tell about Indexed Annuities think they are too good to be true. Imagine, a savings vehicle that allows you to take advantage of market gains without subjecting your initial investment to market losses. So what's the catch? While funds in Indexed and Fixed annuities are protected against market loss, most have surrender charges if you wish to surrender the entire annuity and collect your entire investment early. Indexed annuities allow the owner to withdraw, penalty free, 10% of the policy amount every year. So, if you invest $100,000 in an annuity, you may take $10,000 per year penalty free. If, however, you want to take out the whole $100,000 early, you will be subject to a surrender charge. The surrender charge is levied for a very important reason. Annuities are designed to help people save for retirement. They are not intended for short term savings and are not meant to be withdrawn before annuitization. Each year the surrender charge decreases until there is no surrender charge. Policies range from no surrender fee, to as many as 16 years.

So how exactly do indexed annuities work? Essentially, you invest your money with the insurance company of your choice. The interest earned on your account is calculated based upon stock market performance. Most commonly, the performance of the Dow Jones or S&P 500 is used to calculate your interest. You may select which funds your money is invested in, and you receive a portion of the gains if the selected fund does well. If the selected fund or funds do poorly, you neither lose money nor earn any. Your initial investment is protected from market risk.

Investment risk is not the only type of risk, however. Though Indexed Annuities protect you from investment risk, they cannot guarantee your investment against inflation risk. Though the potential gains in an indexed annuity are attractive, it is also possible that the credited interest will not be able to out run the rate of inflation. Diversifying your fund investments can help protect against this risk but cannot eliminate the risk completely.

The risk focused on by the Dateline story surrounds the aforementioned surrender charges. The concern is a realistic one. What if I invest $10,000 in an annuity today, and tomorrow lose my job? Next week my roof caves in? Next year all of my children need braces on the same day? This is where the new age financial professional takes the reigns and attempts to educate his client. Retirement savings are very important if you want to make your Golden Years golden. However, those savings only really help if you do, in fact, save them. Retirement funds are not emergency savings accounts. All of the tax advantages to annuities are in place to enable the investor to save toward their retirement, not cut and run. Surrender charges are not unlike the penalties levied for cashing in a certificate of deposit or savings bond before maturity. The ability to withdraw up to 10% without penalty does provide for unforeseen emergencies where there is simply nowhere else to turn. In short, if you expect you will need your retirement savings in a lump sum within the next few years, you should consider an annuity with a 3-5 year term or, perhaps, reconsider the amount of money you intend to put away for retirement.

Indexed annuities are a great product that can be of help to many people. I personally invest my retirement savings in Indexed Annuities. Like any other insurance product, however, one must take personal circumstances into consideration to ensure that it best meets the client's needs. When planning for your retirement, be sure to sit down with a financial professional who offers a wide variety of products and is willing to explain all of your options to you so that your needs are being met.