all about Fixed index vs.variable annuities

1. Fixed Index vs. Variable
Annuities
by
The Annuity Reporter
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2. Lifetime income riders on annuity products are becoming
increasingly more popular and relevant given today’s
economic climate and the sheer number of people
approaching retirement. I don’t know the exact percentage
but the majority of newly issued fixed index and variable
annuity contracts carry a provision for guaranteed lifetime
income.
The reason? Consumers are happy to know that a check is
guaranteed to arrive each month during retirement
regardless of how the market performs. Anyone who invests
in the stock market has been burned at one point or another.
For the average investor, it happens more frequently as most
people don’t have the time or expertise to apply technical
analysis to retirement planning. In reality, many pros have
trouble as well.
When we’re talking about legitimate guaranteed income
products, consumers need a viable source of quality
information. Why? Potential consumers are likely to be
given only one option from most advisors that recommend
these products. That doesn’t mean you’ll get a bad deal but
it does mean there might be a better deal out there.
Let’s get down to business…
There are currently two major players in this market,
companies who offer fixed index annuities and companies
who offer variable annuities. The product you ultimately
choose will depend entirely on personal preferences.
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3. Here’s how variable annuities work
Since a variable annuity gives the opportunity for full market
participation, you will be invested in a combination of mutual
funds and bonds for the most part. In exchange for full
growth potential, you will also carry the risk of loss of
principle. You know how that works. That’s where the GLWB
comes in. It doesn’t matter if the market tanks, a minimum
level of income is guaranteed and that level of income can
increase if the market does well over time.
Variable annuities carry additional fees to account for the
insurance protection provided. When charges for company
expenses, asset management and the income rider are
tallied you’ll be looking at no less than 3.5% in today’s
environment.
As for the guaranteed lifetime withdrawal benefits, the level
used to calculate income payments increases annually. It is
typical to see annual increases, or roll-ups as they are called,
to hover in the neighborhood of 5%-6%.
When it comes time to take income, you will receive income
from the GLWB balance or the account balance, whichever is
greater. Payout rates will start around 4% at age 60 and
usually increase by a half percent for every five or ten years
you wait to take income. Downward adjustments to the
payout rate will be applied for joint contracts.
Remember, this is a general analysis of what’s available in
the current market. Each variable annuity contract will be
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4. slightly different.
Here’s how index annuities work
With a fixed index annuity you get partial market
participation in exchange for a principal guarantee. Your
upside growth is limited but there is no downside. Let’s not
forget that this is essentially a fixed annuity where the
insurance company buys a portfolio of bonds and credits the
account with the interest earned on that portfolio. With an
index annuity the growth is based on purchasing index
options with the annual interest earned from the bond
portfolio. So growth in an index annuity contract is subject
to an external market index but the principal is stuck in
bonds so no loss of principal can occur. Please refer to the
Fixed Index Annuity Report for more details on how this
works.
Index annuities use various means to price each contract
including cap rate, participation rates and a spread. This is
also discussed in further detail in the Fixed Index Annuity
Report. As far as fees go, income riders usually cost about .
75% annually on most contracts.
The income benefit also is guaranteed to increase annually
with index annuities. That’s where the major benefits to
index annuities start; with the annual roll-up on the
guaranteed lifetime withdrawal benefit. These rates are
currently running at 7%-8%.
Of course with this product type, you’ll also be planning on
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5. taking income at some point. It works the same here as with
variable products. Income will be based on a percentage of
the account value or guaranteed lifetime withdrawal benefit,
whichever is greater. The benefits continue here with payout
rates generally starting about .5% higher than variable
annuities.
Why are Index annuities more competitive?
Yes, there is no comparison between index and variable
annuities for purposes of guaranteed future income. The
reasoning is simple.
Variable annuities are backed by an unstable asset base that
is constantly fluctuating. This makes it difficult for an
actuary to price. Because of the volatile asset base, future
projections come with a great deal of variance. As a result,
guarantees need to priced very conservatively.
Index annuities carry high-grade bonds for an asset base.
Future projection are then much easier to price because the
principal investment is exposed to little or no risk. In turn,
the company can offer guaranteed income rates according
traditional variables like principle, mortality and interest
rates. Insurance companies have nailed that calculation for
longer than any of us has been around. When an unstable
variable is added to the equation, the guarantees take a hit.
How To Choose Which Product
My advice is to always take the highest guarantee available.
Honestly, that’s what annuities are all about. But that means
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6. everyone would always take the fixed index annuity if given
the option. I certainly don’t think that should be the case.
There will always be people who want to be active in the
market. Because variable annuities offer unlimited growth
potential, the risk of loss is worthwhile to a certain class of
investor.
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