The Benefits of Annuities or Principal Protection Programs

PPP, Principal Protection Programs

Your Nest Egg

Properly structured annuities should be thought of as PPP, Principal Protection Programs. These investment products can completely isolate you from the volatility of the Stock Markets. These programs can provide absolute principal protection regardless of what happens with the stock market. Some Principal Protection Programs (Annuities) can also guarantee income for life, regardless of how long you live.

Getting the right advice regarding annuities is critical as some annuities are very expensive and some do NOT provide principal protection.

Annuities are investment contracts from insurance companies. Annuities may be ideal for conservative investors who are seeking a better alternative to low interest bank rate products like CDs. Fixed and Fixed Indexed Annuities (FIA) may be ideal for that portion of your investments that you do not want exposed to the risks of mutual funds or the stock and bond markets, but still want a competitive rate of return. Fixed Indexed Annuities may have substantial gain possibility without any stock market risks. Many annuities have guaranteed lifetime income features, which is why many people chose them. Conservative and secure lifetime guaranteed income is the big appeal for many annuity buyers.

The number one fear of retirees is outliving their money. Annuities can solve that problem by providing life-long financial serenity.

Many advisors believe that the first step in planning for retirement is establishing a guaranteed inexhaustible income stream before investing your remaining assets in riskier, possibly higher performing investments. In short, part of your retirement nest egg should be protected from the volatility of the stock and bond markets, and possibly should also provide guaranteed income-for-life.

An indexed annuity enables individuals to create their own private pension account with the security of a large insurance company guaranteeing principal safety and income-for-life features.

Let’s start the annuity discussion by addressing the negative and misleading spins that are often in the media. This negativity stems from the miss-understanding of the substantial differences between variable and fixed indexed annuities. These misconceptions get in the way of understanding the great benefits of fixed indexed annuities.

1. (Misconception #1) Annuities have high commissions. In contrast, you pay no commissions! There are no commissions when buying a fixed indexed annuity. All of your money goes to work for you immediately. Your annuity advisor gets a finder’s fee directly from the insurance company that does NOT directly affect your investment. Other types of annuities do have commissions.
2. (Misconception #2) Annuities have high fees. Yes, many variable annuities have higher fees. However, most fixed and fixed indexed annuities have no fees unless you elect certain optional income or death features that may have rider fees.
3. (Misconception #3) Annuities have high surrender fees; therefore, your money is not liquid. Annuities are longer term investments, and most annuities have a declining surrender fee if you withdraw too much money too early. These fees are typically less than 10% and occur only in the first 5 to 10 years of the annuity. These fees also decline to zero over the first 5 to 10 years. Furthermore, most surrender fees can be avoided if you limit your withdrawals to only 10% per year. Even with a full 10% surrender fee, 90% of your money remains completely liquid from the first day. But for comparison purposes, if you invested in a stock early in the morning you could lose 10% by that same afternoon. The surrender fee is inconsequential when compared to the volatility in other less protective investments.
4. (Misconception #4) You surrender your principal when you start receiving income. With modern annuities you no longer need to annuitize (surrender your principal) to receive periodic life-time income. You still maintain your cash value for a period of time. A residual or death benefit may pass on to your heirs.

Guaranteed safety of principal is the most attractive feature of fixed and fixed indexed annuities.

Unlike with variable annuities, with fixed and fixed indexed annuities your money is not directly invested in the stock market. Your money is held securely by a major insurance company which pays you an interest rate each year. Stock market losses do not become losses in your indexed-annuity account. Even a large stock market crash will not reduce your principal in a fixed or fixed indexed-annuity.

Protection from stock market volatility

Many mutual fund and stock market accounts will experience gains frequently followed by dramatic losses. Withdrawals during these down periods may erode your stock market account’s principal to such a degree that it is very hard to recover. In retirement, withdrawals from a more stable annuity may provide a more appropriate solution.

However, with a fixed or fixed indexed annuity your gains are locked-in each year. Future declines will not erode your principal or earlier gains which have been locked-in. These locked-in previous gains can provide substantial liquidity for your retirement needs when your other stock market investments have declined too low and need time to recover.

The security of a fixed indexed annuity allows you to withdraw from during periods of stock market declines. This allows you to steadily provide for your retirement. This annuity safety-net may allow you to be more aggressive with your other investments.

Guaranteed life-long income is also an attractive feature for many annuity buyers.

Industry reports show that the majority fixed indexed annuities come with an income guarantee. These guaranteed income streams are great for income planning in retirement. You should think of these life-long income streams as a guaranteed private pension. However, most retirement pensions stop making payments and expire when you and your spouse die. In contrast, annuity-based income streams (pensions) may provide residual benefits for your heirs.

The income guarantee feature is a planned periodic withdrawal from the annuity’s cash value. If the cash becomes exhausted, the insurance company must continue making payments until the annuitant(s) dies. This means you can’t outlive your investment. A huge advantage you can only get from annuities.

Fixed and fixed indexed annuities provide only positive growth. Declines in either the stock or bond markets will not cause your indexed annuity to decline. You will never experience a market related decline in a fixed or fixed indexed annuity. They are as safe as the insurance company that guarantees them, which is very safe. Insurance companies typically have much greater asset reserves than banks.

Annuity growth rates compare highly favorably to many bank-rate products such as CDs. Although not designed to compete with the investment returns of the stock market, the absence of the need to recover from negative returns can make fixed indexed annuities comparable to long-term stock market returns without the volatility.

The cash value of some indexed annuity contracts can continue to grow even after an income-for-life feature has been activated. This increases the possibility of remaining cash value being available to your heirs after you are gone.

The income-for-life payments of some fixed indexed annuities can possibly continue to grow in size even after activation. This income growth could exceed the negative effects of future inflation. This is a newer and significant feature of some annuity contracts. We recommend you seek out these contracts.

Some annuity companies charge a rider fee for the income guarantee while others offer this income guarantee for free.

As insurance companies need to design more competitive product, rider fees for guaranteed income are slowly going away. There is seldom a need to pay for an income rider anymore. Due to improving features and fees structures, since 2022, reviewing your current annuities may result in a higher paying lower cost annuity in your retirement. Reviewing all variable annuities is worth-while.

Similarly, it might be worth-while to review your company’s pension compared to the investment of the lump sum distribution into a private pension annuity. See the section on pensions.

When planning your retirement, you should also review your family history of longevity. This is particularly true if the annuitant is in great health and has a family history of long life. In fact, a family history of long life can make an income-for-life guarantee annuity more valuable.

Fixed indexed annuities provide isolation and protection from stock market volatility.

With a fixed indexed annuity, your money is not invested in any stock index. But you may receive an interest credit that is partly determined by the value change in the selected index. With the up-year caps and the down years avoided, the cash values of many indexed annuities can expect an average performance in the 4 to 9% range, a modest but safe investment. Some interest crediting methods limit the upside with participation rates while others use caps. Regardless of the crediting method, fixed index annuities protect you from stock market declines.

In recent years, particularly since 2022, these rates have been substantially increasing, making FIAs a more competitive investment. Some indexed annuities may offer index crediting methods that are often better than other low volatility investments. Sometimes you can find a fixed indexed annuity that has a crediting method with a proven history of 4 to 9% average returns per year to the cash value of the account.

An indexed “growth” annuity offers tax-deferral and protection from the stock market declines while providing the possibility of enhanced interest credits. They typically offer much better returns than most bonds and bank rate products (CDs).

If an annuity buyer focuses on the cash value growth, some indexed annuity policies offer enticing index crediting methods that provide for substantial real cash value growth. This growth can be in the 4 to 9% range which is very respectable for safer investments and attractive for risk adverse people. Indexed growth annuities provide safe growth isolated from the stock market volatility.

Fixed indexed annuities offer significant growth possibilities.

You can ask the insurance agent to run a hypothetical illustration of the cash value growth. If this cash value growth is in excess of 5% average annually for the last 10, 15 and 20 years, you are viewing an annuity worthy of consideration. This real cash growth can be drawn upon when an income stream is needed or used to purchase a much higher paying bonds when interest rates return to a more desirable level.

Some of the better annuity contracts focus on the cash value account growth and offer income guarantees without any rider fees. These are the annuities that are most worthy of your consideration. The income guarantee can be a nice feature if it does not reduce your cash value account growth due to an attached rider fee.

The danger with variable annuities

We don’t recommend investing in variable annuities. Variable annuities invest in the stock market through mutual funds and do not guarantee principal protection. Your annuity cash value can decline as the stock market and mutual funds decline. Exposure to stock market risks coupled with higher-fees make variable annuities non-optimal for most investors. However, many brokerage firms recommend them due to the high fees they generate for the brokerage firm. We recommend only fixed or fixed indexed annuities for safe growth.

Curtis Hill, CFP, IAR and Irina Hill, CPA, IAR, provide fiduciary financial advice, investment advice, retirement planning, and life insurance in the Long Beach, CA; Lakewood, CA; Carson, CA; Bixby Hills, CA; Signal Hill, CA; and Los Angeles, CA areas. Serenity Wealth Management also provides advice on how annuities can provide principal protection guaranteed income as well as significant investment gains.

Is a principal protection program or an annuity the right investment for you? Do you have an older annuity that needs a performance review? Annuity issues before 2022 often have much lower rates than today’s annuities. Click here to download your free report with more information about annuities.