Greg Roberts

Greg Roberts

In 2017, the sales of indexed annuities surpassed $65 billion. The demographic segment of the population that purchased the bulk of these products were those age 65 or older.

Now that the Dow Jones Average has dropped 20 percent this month, unscrupulous peddlers of these products will likely play on investor fears and tout these products as being the best way to get protection of one’s principal with the possibility of some upside growth.

An indexed annuity is a contract issued by a life insurance company. You make a payment of money (your premium) either in a lump sum or in periodic amounts, and the insurance company will offer you protection against downturns in the stock markets. Additionally, the insurance company will provide the potential for some investment growth that is linked to an underlying stock market index such as the S&P 500 Index. Through the use of optional riders, a guaranteed lifetime income can also be made available.

The calculation of the actual investment return in indexed annuities can be complicated and confusing. The amount of interest that you will actually earn depends on how the underlying index changes over different time periods – a month, a year, or perhaps longer. After the gross return is determined, how much you receive depends on several factors:

• The participation rate means how much of the increase in the stock index will “count” to determine your credited interest rate. If the participation rate is 90 percent and the index goes up 10 percent, your return would be 9 percent.

• Interest rate caps set a maximum rate of interest that can be earned during a period. If the index earned 10 percent and the cap were 4 percent, you would receive 4 percent.

• Spread or margin means that a specified amount of gain from the index increase will be subtracted to determine your actual interest credit. A spread of 5 percent means that if the index goes up by 6 percent, your product would earn 1 percent during the applicable period.

The indexing method itself can dramatically impact the return that an investor would receive, and these methods are complicated as well. Often investors will depend on the agent or broker to select a crediting method for them, which can be a mistake.

Many IA’s provide a guarantee of principal, while a smaller number will guarantee a minimum interest credit. Most products will guarantee a minimum rate of return of 1 to 3 percent of 87.5percent of your premiums. So if you invested $100,000, you would be guaranteed from 1 to 3 percent on $87,500.

All of these products have surrender penalties during the first five to 10 years, so you should be willing to keep your investment intact for at least the duration of the penalty period. The surrender fees for the 10 top-selling equity-indexed annuities averaged over 11 percent in the first year. Then too, a longer surrender penalty period invariably means more commission for the agent or broker. Don’t be shy about asking the agent what his commission will be on the sale.

It is vitally important that prospective buyers completely understand how these products work before signing any documents. Another safeguard I recommend is that you only consider companies that are at least rated A+ by A.M. Best.

Personally, I would never purchase a product that was “pitched” to me at a free dinner or lunch. Most successful agents obtain client referrals, so what does it say about an agent who must host a free meal to generate prospects?

Could you lose money? In some case, yes, if the market index drops and your product offers no minimal rate of return. Remember that your principal is protected only if you hold on to the annuity until the surrender penalty period expires.

As you can discern, I am not a big fan of indexed annuities. Caveat emptor.

Greg Roberts is a certified financial planner with 35 years of financial and estate planning experience. Do you have a financial planning question for Greg? Email him at