Financial Matters (Winter 2016) – Why Are Annuities So Complex?

In the February 2015 issue of Capital Conversations, REDW’s Director of Client Services Laura Hall, provided a primer on the pros and cons of the various types of annuities.  While most types of annuities range from simple to somewhat difficult to understand, the word ‘index’ in the product name should send your antenna high for the complexities, costs and limitations involved.

‘Indexed’ annuities (sometimes called ‘equity-indexed’ annuities) were a reaction from the insurance industry to investors wanting to participate in the market but not experience the downside (‘have cake and eat it too’).  Hence, a product that participated on the upside and protected the downside.  But at a cost of additional fees and limits on access to your funds.
Like other annuity products, ‘indexed’ annuities are a contract between you and the insurer.  The financial strength of the insurer is paramount in ensuring that they can meet these commitments.  But the complexity of the product and optional features (riders) can be difficult for anyone, including insurance agents, to understand.

Two of these complexities of ‘indexed’ annuities are the participation rate and the Guaranteed Lifetime Withdrawal Benefit (GLWB). The participation rate is the percentage of the growth of the index that you are credited with and insurers may use one of many indexing methods to measure the gains or losses, resulting in strong variations of outcomes to compare policies. For example, if the index grows 10% during the year but your participation rate is only 80%, you are only credited with 8% for the year.  Should the index perform below the minimum guaranteed interest rate, the insured would be credited with the guaranteed minimum interest rate. Most ‘indexed’ annuities do not count reinvested dividends as part of the index’s growth, which can be a major component of an investor’s total return.

Also remember that you are not directly invested in the index as this is for accounting purposes only.  Unless the funds are in a variable annuity, your premiums are part of the general assets of the insurer, subject to the claims of creditors.

Another complex feature of these annuities (including variable annuities) is a Guaranteed Lifetime Withdrawal Benefit (GLWB).  This feature gives you an annual withdrawal based upon the greater of the actual cash value attained or the premiums paid at the time of election.  Many annuities credit a minimum rate of return to the premiums paid based upon when you elect to begin receiving withdrawals.  Often, the longer you defer the start of payments, companies will credit a higher rate of return.  Example- starting in five years at age 65 may yield a 5% credit while waiting until age 70 or beyond would yield a higher annual credit.  But at the later age, you would expect less years of living and consequently less years of annuity payments.

Unlike annuitizing an annuity where you give up the cash value for a stream of lifetime payments, the GLWB may allow additional withdrawals to be made but this can negatively affect future withdrawals and the crediting percentage used.  Remember, the interest crediting is an accounting feature that can be reduced or eliminated if you don’t play by their rules.  As with any rider, there is an annual cost for the option which affects the cash value in addition to mortality and other administrative expenses of the policy.  For a variable annuity, these costs can be as high as 4% because of the added expense of the separately managed accounts.

A few years ago when I first looked into this feature with a variable annuity, I thought great- select a risky portfolio and if it performs poorly, the GLWB option is still there.  But insurance companies were a little quicker by limiting the investment options to a narrow range of safer, more conservative choices limiting the growth potential and their exposure to assuming more risk.

Overall these policies have so many costs and limitations that in reality make the product less desirable than the promotions.  If you have any questions about these products, please contact us. We will be happy to work with you and your insurance professional.

Protecting Yourself in an Electronic World

In today’s environment, there are stories almost daily about personal information being hacked from many sources thought to be secure, including government databases.  While you can’t prevent every occurrence, you can take some steps to reduce your exposure.
Jennifer Moreno, Senior Manager in REDW’s Information Technology department, recommends the SANS.org  website, which includes information for all levels of knowledge including a Security Tip of the Day and the OUCH! Newsletter.  In addition, Jennifer has provided some common tips that can easily be implemented now:

Social Security Turns 80

August marked the 80th birthday of the Social Security Act, signed into law by President Franklin D. Roosevelt in 1935.   Some tidbits- during the first 12 years of the program, the withholding rate was 1% on the first $3,000 of earnings, matched by your employer (that’s only $30 per year, each).  Today, the rate is 6.2% on the first $118,500, again matched (maximum contribution of $7,347 each).  Five years later in 1940, the first monthly benefit paid was $22.54 (about $375 today).  And until 1984, Social Security was not taxed federally but now can be taxable up to 85% of benefits. My, how things have changed.

Today, the full retirement age (FRA) is slowly increasing from age 66 to 67 but benefits can still begin as early as age 62, although with up to a 25% permanent cut in benefits.

On a related note, there is often confusion of coordinating the beginning of Social Security and Medicare.  These are really two separate events.  You can begin Medicare as early as age 65 or wait until you retire later assuming you have ‘creditable’ health coverage through your or your spouse’s employer.  An exception to this rule is that once you elect to begin Social Security benefits (including some deferral elections) and are at least 65, you must begin Part A of Medicare (the no premium portion).

Social Security and Medicare elections can be a complicated subject so please contact us with any questions or for an evaluation of maximizing Social Security strategies.