Who Even Needs an Annuity Anyway?

In ultra-conservative safe money you basically have four options:

1. A CD

2. The Cookie Jar

3. Cash

4. A Fixed/Indexed Annuity

Annuities are similar to CDs. They are for specified periods of time, there is a surrender or penalty charge if withdrawn early, and the higher rate you get, the higher the penalties will be if withdrawn early.

A CD is backed by the bank and the FDIC where an annuity is backed by the assets of the insurance company and the Life and Health Guarantee Association set up to help protect consumers.

When money is placed in a fixed/indexed annuity, the policyholder can elect to allocate money into a “fixed” bucket that pays a stated interest rate, usually with a guaranteed minimum. The policyholder can also elect to allocate money into various “indexed” buckets that vary by contract. These indexed buckets accrue interest based on the market index they follow with a stated cap. Let’s say your annuity is allocated to the S&P 500 index for a year period and your annuity’s cap is 8%. If the S&P 500 goes up 10% that year, your annuity will be credited 8%. Here comes the power of annuities: if the S&P 500 LOSES 10%, your annuity will avoid the losses. What does that look like? What if we went to a casino and I told you: “I will cover all of your losses, but you have to split your winnings with me”. Would you take my offer? That is basically what the insurance company is doing. They are pooling thousands of policyholder’s capital and offering to share earnings with you and cover all the downturns.

If you think the bank is in a stronger position than the insurance company, consider this: The only building as tall as the bank’s in a major city, is the insurance company’s building. between 2008 and 2012 only eight insurance companies went insolvent with a combined liability of $900 million. A fraction of the $639 billion in Lehman Brothers bankruptcy. And those policyholders with the insolvent insurance carriers received all their contractual benefits.

There are several important considerations when contemplating purchasing an annuity. The insurance company needs to make a buck. They are going to pay you a bonus as a policyholder, pay the adviser, they don’t charge a management fee, so therefor they need to hold on to at least a piece of the money for a period of time in their portfolios to turn a profit. Therefore surrender charges are in place to discourage too much withdrawing in early years.