Short term equity indexed annuities

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ZachFinch76
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Short term equity indexed annuities

Post by ZachFinch76 »

I am trying to convince myself they are a bad move. But in the context of using them instead of bonds, it seems like they have more potential upside vs bonds.

Here is my thinking:
- There are different reputable insurance companies offering different options. To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.

Pros:
- Protect the principle and gain as much as 6% if the market does at least that well, which would beat bonds at this point

Cons:
Insurance company default risk, even a reputable financially strong company could go belly up, but since I would be looking to do this in 1 year increments, it seems low risk.

Thoughts?
Thanks
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vineviz
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Re: Short term equity indexed annuities

Post by vineviz »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm Thoughts?
Seems like a lot of uncertainty to take on when compared to the ability to get a guaranteed 2.5% to 3.5% over the same period of time with CDs, MYGAs, or target maturity bond ETFs.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Stinky
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Re: Short term equity indexed annuities

Post by Stinky »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm I am trying to convince myself they are a bad move. But in the context of using them instead of bonds, it seems like they have more potential upside vs bonds.

Here is my thinking:
- There are different reputable insurance companies offering different options. To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.

Pros:
- Protect the principle and gain as much as 6% if the market does at least that well, which would beat bonds at this point

Cons:
Insurance company default risk, even a reputable financially strong company could go belly up, but since I would be looking to do this in 1 year increments, it seems low risk.

Thoughts?
Thanks
Most indexed annuities have surrender charges that restrict your full access to your money. The surrender charges can go in for as long as a decade or more, depending on the product.

Does the product you’re looking at have surrender charges?

Also, if you’re looking at annuities as a fixed income investment, have you considered multi year guaranteed annuities (MYGAs)? Many MYGAs are now paying 4% or more, guaranteed for the entire policy term. Post back for more details.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
exodusNH
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Re: Short term equity indexed annuities

Post by exodusNH »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm I am trying to convince myself they are a bad move. But in the context of using them instead of bonds, it seems like they have more potential upside vs bonds.

Here is my thinking:
- There are different reputable insurance companies offering different options. To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.

Pros:
- Protect the principle and gain as much as 6% if the market does at least that well, which would beat bonds at this point

Cons:
Insurance company default risk, even a reputable financially strong company could go belly up, but since I would be looking to do this in 1 year increments, it seems low risk.

Thoughts?
Thanks
Keep in mind these usually excluded dividends. They're usually just price indexes. You're giving up 2%ish right off the top.
bberris
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Re: Short term equity indexed annuities

Post by bberris »

You'd do better to buy the bonds or notes corresponding to the term, and the index call option with the interest paid on the bonds. Protects the principal, and you can gain if the market does.

That's what the insurance company does, but they shave about 3 % from your return.

And you would have liquidity if you need it, but market risk in between maturity/expiration.
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nisiprius
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Re: Short term equity indexed annuities

Post by nisiprius »

An important con, as noted by others, is that S&P 500 index funds get you the S&P 500 total return index, while these annuities get you the S&P 500 price index, and that's a big and important difference.

You can explore it with this CAGR of the Stock Market calculator which can show you the difference in growth with and without dividends. For example, over the five-year period, the total return you would have gotten in an index fund average 18.55%/year, but the price return was only 16.31%/year.

Another con is that these products are obfuscated and difficult to understand, and the proof is that you yourself didn't understand them because you didn't notice this issue yourself.
ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pmCons:
Insurance company default risk, even a reputable financially strong company could go belly up, but since I would be looking to do this in 1 year increments, it seems low risk.
I think equity indexed annuities are bad. I've never seen anybody independent of the insurance business with a good thing to say about them. However... that part should be OK. Go to the website

https://www.nolhga.com
>> policyholder information
>> find your guaranty association
>> (choose your state from the popup)
>> FAQs

and read the FAQs to understand what your state guaranty association does.

There is some protection. Contrary to what they want you to think, your investment is not backed only by the insurance company, but also by the "state guaranty association." It is "protection," it is not "insurance." It's not comparable to FDIC deposit insurance. The guaranty association has wide scope for judgement in how they handle an insolvency. The guaranty associations are not state agencies and don't have a pool of money from which to draw on. But if your insurer becomes insolvent, you are protected, and the FAQ will tell you the rules and the limits. For example, in Connecticut, the guaranty association protects "Annuity Benefits (Present Value): $500,000 per contract owner."

Because insurance is regulated by state law, the exact law and details are different for every state, but they follow a similar pattern.

I'm not kidding when I "contrary to what they want you to think." They really don't want you to know about the guaranty associations, and most--all?--of the state laws actually make it illegal to mention it in an advertisement.
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bberris
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Re: Short term equity indexed annuities

Post by bberris »

This diversion to insurance company default risk is a sort of slight-of-hand. Pay no attention to the high fees and lack of liquidity; just pay attention to this extremely remote chance of a disaster. I see the same obfuscation with stable-value funds: focusing on the remote chance of insurance bankruptcy hides the much more likely chance of breaking the buck.

Insurance companies are highly regulated and they know how to offset risks.
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Stinky
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Re: Short term equity indexed annuities

Post by Stinky »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm I am trying to convince myself they are a bad move.
Hopefully the posts upthread have helped to convince you that they ARE a bad move.
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nedsaid
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Re: Short term equity indexed annuities

Post by nedsaid »

I remember contributing to a thread on these products. I did a research project to find performance information on these and I may as well have been googling the secret codes to launch a nuclear strike. There just wasn't much of anything out there. So again, I am asking the question: how are these products actually performing?
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exodusNH
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Re: Short term equity indexed annuities

Post by exodusNH »

nedsaid wrote: Thu Aug 11, 2022 8:18 am I remember contributing to a thread on these products. I did a research project to find performance information on these and I may as well have been googling the secret codes to launch a nuclear strike. There just wasn't much of anything out there. So again, I am asking the question: how are these products actually performing?
This person discusses indexed universal life: https://youtu.be/HYhfX1g6uYw

The annuity won't have the insurance charge (and returns will be better) but the flavor is there. Of course this annuity is only buffered, not a floor of 0. Insurance companies also issue "new" products every couple of years so they can sweep the cap rate reductions under the rug.
Rex66
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Re: Short term equity indexed annuities

Post by Rex66 »

Miserably compared to initial illustrations/projections that thought of them as stock like

Ok as compared to regular deferred annuities although as mentioned they roll out new ones to hide cap decreases.

Keep in mind 98% of the product is the same as a regular deferred annuity

Some agents refer to the initial caps as teaser rates
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PicassoSparks
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Re: Short term equity indexed annuities

Post by PicassoSparks »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm - There are different reputable insurance companies offering different options. To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.
The way the stock market moves up and down, it is very rare to have any particular year match the average return of the market. They tend to either be way above or way below.
Image (source https://www.macrotrends.net/2526/sp-500 ... al-returns)

So some years you will get 6% while the S&P goes through the roof, while other years you will get 0%. That seems like a bad deal and a lumpy way to just get a performance that'll probably be in line with bonds or other fixed income.
exodusNH
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Re: Short term equity indexed annuities

Post by exodusNH »

PicassoSparks wrote: Thu Aug 11, 2022 10:59 am
ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm - There are different reputable insurance companies offering different options. To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.
The way the stock market moves up and down, it is very rare to have any particular year match the average return of the market. They tend to either be way above or way below.
Image (source https://www.macrotrends.net/2526/sp-500 ... al-returns)

So some years you will get 6% while the S&P goes through the roof, while other years you will get 0%. That seems like a bad deal and a lumpy way to just get a performance that'll probably be in line with bonds or other fixed income.
It's only a buffer on the downside, not a zero floor. Once that buffer is exceeded, they will take a hit.
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Re: Short term equity indexed annuities

Post by Jack FFR1846 »

Something I find in any of these annuities is that they sell that any gains are tax deferred. Customers almost always convert that in their heads to be tax free. And they absolutely are not tax free. Now, the tax can be low, but why is that? It's because the costs are so high over the years that what finally comes out as cash is so low that there's not much to tax.

Different product, but I had a Universal Life policy that my dad set up. Just under $400 a year for 27 years. The tax, which applied to cash out that was more than what was paid in was on the amount of $20. Twenty dollars. So at about 30% tax, I paid $6 in tax. Why? Because I made all of $20 in 27 years. Wonderful product, eh?
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PicassoSparks
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Re: Short term equity indexed annuities

Post by PicassoSparks »

exodusNH wrote: Thu Aug 11, 2022 11:04 am It's only a buffer on the downside, not a zero floor. Once that buffer is exceeded, they will take a hit.
Oh! Well that's an even worse deal.
Rex66
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Re: Short term equity indexed annuities

Post by Rex66 »

One needs to recognize that there are equity index products which have a zero floor bc none of the money is invested directly in market (98% general insurance account and 2% options )and then there are variable annuities with costs for protection and typically limit both the up and down but not routinely a zero floor. Neither is a good product but they are a tad different.
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Re: Short term equity indexed annuities

Post by arcticpineapplecorp. »

ZachFinch76 wrote: Wed Aug 10, 2022 1:01 pm To me one of the most favorable is a no fee 1 year SP500 index based annuity with a cap of 6% growth and capital preservation level set at 100%.
can you tell us what you're seeing. I'm not finding what you're reporting.

also, do you know how much the market has to go up to make the 6% cap on growth?

do you know what you make if the market makes less?

if it's truly "no fee" then how does the insurer make money?

do you believe annuities are insurance products as Jorge Soriano told us on the recent bogleheads live?

if so, why are you taking money from investments and putting them in insurance products?

do you think indexed annuities are investments? they're not.
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petulant
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Re: Short term equity indexed annuities

Post by petulant »

Insurance companies offering these annuities are using, directly or indirectly, options to create the strategy payoffs. They have bond portfolios that generate income which is used to offset the budget for buying the relevant options. For example, the insurance company might allocate a portion of its general account bond portfolio equivalent to a 4% return. That math means 3.85% of a $100 investment might go to options since the remainder (96.85%) will grow at 4% to $100. The insurance company can buy a call option and then sell one with a higher strike price to get the desired exposure within the budget, and still offer a guarantee of no losses.

The problem is, how could the insurance company offer these with any benefit? One thing to note is that evaluating whether they are fairly priced compared to option strategy payoffs can be complex but is possible--and maybe, they are fairly priced. OP posted in a separate thread here about a product that, based on my review, was fairly priced. But given that it was Nationwide and given recent experience on BH, I question whether that product was actually available without some insurance agent or RIA charging 1-1.5% per year or having some other unbundled marketing/distribution charge. Most investors do not have the sophistication to evaluate whether a specfic equity indexed annuity, RILA, or whatever you want to call it is fairly priced. Nor is it clear why any of these strategies are better than traditional stock/bond portfolios, as discussed here and here, or some other product like a MYGA.

Now, past that, if for some reason a saver had a significant motivation to use an options-based strategy, there is one silver living. It *may* be possible to serially perform 1035 exchanges to defer the profits of this strategy over a long period of time. A big con of the options-based strategy is that since the instruments are closed or rolled regularly, taxes would be incurred regularly. A tax deferral might be beneficial, but really only makes sense for tipping over to these IF the annuity is fairly priced against the options strategy in the first place. As we have seen in some annuity threads recently, this requires not just that the insurance/annuity expenses be less than tax drag, but they must be less than the tax drag *after taking into account that the tax drag reflects increasing the basis*. This is possible, or it may result in only a minor underperformance, but it affects the extent to which these are good deals, mildly underperforming deals, or bad deals.

For example, this recent thread mentioned an annuity with internal expense of 1.5% that, without doing more investigation, strikes me as likely a pathway to compensate the salesman and a huge drag on performance that cannot be fixed.
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ZachFinch76
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Re: Short term equity indexed annuities

Post by ZachFinch76 »

I am meeting with some reps from Schwab today to learn more about a few different product offerings from different companies (not Nationwide) -- if I get more useful info I will share it here in the thread.
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ZachFinch76
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Re: Short term equity indexed annuities

Post by ZachFinch76 »

And just to clarify, if I did do one of these equity indexed annuities I would never consider it a substitude for investing in stocks directly, I would only look at it as part of the fixed income side of my asset allocation.
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Stinky
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Re: Short term equity indexed annuities

Post by Stinky »

ZachFinch76 wrote: Fri Aug 12, 2022 11:05 am And just to clarify, if I did do one of these equity indexed annuities I would never consider it a substitude for investing in stocks directly, I would only look at it as part of the fixed income side of my asset allocation.
As mentioned upthread -

If you want to purchase an annuity as part of your fixed income allocation, you’re almost certainly better off with a MYGA than with an indexed annuity.
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exodusNH
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Re: Short term equity indexed annuities

Post by exodusNH »

ZachFinch76 wrote: Fri Aug 12, 2022 11:03 am I am meeting with some reps from Schwab today to learn more about a few different product offerings from different companies (not Nationwide) -- if I get more useful info I will share it here in the thread.
Their sales people are very good because they get huge commissions in those products.

Stick with a MYGA. BTW, Stinky worked in a high-level role at a major insurance company. Ignoring his advice on these products is like ignoring a chemist's warning not to drink a particular substance.
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Re: Short term equity indexed annuities

Post by vineviz »

exodusNH wrote: Fri Aug 12, 2022 11:31 am
ZachFinch76 wrote: Fri Aug 12, 2022 11:03 am I am meeting with some reps from Schwab today to learn more about a few different product offerings from different companies (not Nationwide) -- if I get more useful info I will share it here in the thread.
Their sales people are very good because they get huge commissions in those products.

Stick with a MYGA. BTW, Stinky worked in a high-level role at a major insurance company. Ignoring his advice on these products is like ignoring a chemist's warning not to drink a particular substance.
IMHO, indexed annuities generally only have two legitimate uses:

1) as a tool for uncovering the economic motives of the people selling them;
2) as a tool for uncovering the behavioral and/or cognitive biases of the people buying them.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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