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

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

February 2, 2016


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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  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:

  • Account passwords should be complex with at least 8 characters using upper and lower case letters, special characters and numbers.  Mix up letters for numbers (i.e. B or 8, a or @, L or 7, E or 3, I or 1 or!).  Don’t use your name or important dates as your password.  As painful as it is, don’t use the same login credentials for all of your online accounts. Separate banking, shopping, credit cards, emails, etc. with different credentials so that if one account is hacked, the rest will hopefully be safe. There are password management applications available to help organize all of your credentials for each account so that a person isn’t storing this information in an unprotected document or on random sticky notes.
  • Financial institutions or the IRS will not contact you thru email if there is a problem with your account. Never open attachments or click links in an email from a suspicious sender. Be cautious of opening attachments and clicking links in emails received from people you know. Email addresses can be spoofed and used by somebody with ill intent masking as a familiar contact. If you hover the mouse cursor over the URL link in the message you can often see where the link is really taking you.
  • Never send sensitive information through email unless the email is encrypted using a secure encrypted email system. Secure portals are recommended for transferring documents with sensitive information, and if one is not available be sure to password protect the document with a complex password if it must be emailed. Communicate the password in a separate correspondence.
  • Be aware of how much personal information you post on your social media sites. Hackers, identity thieves, and social engineers love social media because we put everything out there – work info, family info, pictures, important events or dates, when and where people are going on vacations, you name it. It’s a one stop shop for them. Most social media users don’t think about setting privacy on their sites and “friend†just about everyone.  If you have teenagers on social media, this point cannot be emphasized enough.
  • A micro-cut shredder is the most secure option for destroying documents containing personal information. Social engineers and identity thieves are not afraid to rummage through dumpsters to see what they can find. They will also not be discouraged from the challenge of piecing together documents from strip-cut or cross-cut shredders.

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.

Unless you are taking Social Security benefits before FRA, there is little you need to do until then.  However, at the FRA of you or your spouse, some actions may need to be made to make certain elections such as file-and-suspend.

  • Begin the process three months before wanting to start benefits or making certain spousal elections.
  • Experts on social security are advising that the ability to register on-line may be easier than an in-person visit to the local office or telephone call (just remember to set up your online Social Security account with a strong password).

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.

Contact Scott Pelfrey, Senior Manager, D: 505.998.3232, F: 505.998.3333,

Copyright 2017 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice. 

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