There are numerous financial products that are on the market today that can be used as investment tools. One of those options is the indexed annuities. They offer more risk, but also the benefits of a better overall return than a fixed annuity. They’re also a safer venture than variable annuities because the interest rate is indexed. There are some pros and cons to consider with this investment option, so here is a select look at the indexed annuities pros and cons.
The Pros of Indexed Annuities
1. Funds are available for withdrawal.
Many indexed annuities allow for a certain amount of exit money annually if needed. It is usually a percentage that is based on the amount of time that is left on the contractual period that has been agreed to on the initial investment. On a 10 year contract, for example, a 10% withdrawal may be allowed without experiencing a surrender penalty.
2. Commissions and fees are generally taken out of returns.
Most of the expenses that are associated with indexed annuities come out of the returns that are experienced. This means that most fees can be covered by the annual gains every year. Because there is very little volatility with this investment product, a held position over the long-term can create a fair return for a diversified portfolio.
3. Losses are generally minimized.
Any investment brings with it the potential for loss. With indexed annuities, however, those losses are set to a certain level. Most insurers will typically own about 87% of the paid premium of the investor and there’s an interest rate cap of 3% on that premium amount. This means the investment can lose money, especially if indexed interest isn’t earned, but those losses are limited.
4. It can compliment a retirement plan.
If someone has maximized their contributions to their 401k and their IRA, then indexed annuities can be a long-term investment that helps to compliment those retirement products. It isn’t going to be a short-term solution, but the long-term gains could bring about some decent value.
5. Increase your investment return.
Investing your money into an annuity allows your money to keep working for you. Gains are compounded each year, without the requirement of paying taxes on your return. The advantage in the long run? You can grow your money faster than other available investment alternatives.
The Cons of Indexed Annuities
1. The fee structure can be extremely high.
The commissions on indexed annuities may be as high as 10% of the contract amount. It can even be more on certain annuities. Then there are the other expenses of running the annuities and because many of the fees and commissions are taken out of the returns, the average investor may not even realize how much money they’ve lost out of their return when all is said and done.
2. The formulas are ridiculously complex.
How much annuity owners earn every year is such a complex formula that even those who represent this investment product don’t often know how to explain them. These formulas can change even though it is a contracted arrangement as well, which means there is very little investor control over this portfolio item.
3. It is a long-term venture.
Most indexed annuities have a minimum commitment of 10 years. This means investors have to give someone access to their cash for a decade or more with very few options to recover that cash. Add in the fees that get paid out of the returns their annuities earn and the limited access to funds can become very problematic. Cashing out of an indexed annuity is generally allowed, but there will be a surrender charge of at least 10% to make that happen, though most allow for a gradual decrease as time goes on.
4. Most indexed annuities have caps on the amount that can be earned.
The contracts that are associated with indexed annuities are generally capped so that only a certain percentage of the index growth can be achieved. If there was a 25% gain in the market, the investors cap limit might be set at 6% and could be further reduced by the participation rate. At a 50% participation rate in this example with the cap invoked, the investor would see 3%. The other 22% isn’t distributed to you.
Indexed Annuities May Not Be a Popular Investment Product With Many, But It Does Have Some Potential.
There is a guaranteed minimum return, which means losses are going to be limited. Even when gains are capped, the return can still be higher than inflation, which means the money won’t lose value. As long as investors have performed their due diligence on their preferred product, it could be a nice way to diversify.