A Word of Warning on Fixed Index Annuities (or any Fixed Product)

by Wes Bridel on October 1, 2012

in Stewardship

Do Fixed Index Annuities offer some wonderful benefits that you can’t find anywhere else?  Absolutely!  Are they the Be All, End All financial product that you should dump all your money into?  We would strongly urge you not to!  We’ve just spent a couple posts talking about how wonderful FIA’s can be (which you can read here and here.)  And it’s true, that in a deflationary (think 1930’s style Depression) or slightly inflationary environment (like we’ve had for the prior 3 decades), this would be an absolutely fine place to have all your money.

But if we see serious inflation, you would not feel comfortable with all your money here.  In a highly, but controlled, inflationary environment like the 1970’s to early 1980’s, you would see your real value dropping substantially every year  (whether we’re talking principal or income).  In a hyper-inflationary environment like this country has never seen (but like every other country in the history of the world that has our problems has eventually experienced), you would be completely wiped out.

Now, if you had this as a reasonable portion of your portfolio, as we suggest, and had other areas that responded powerfully to severe inflation, you would come out just fine.  Sure, you might have done badly with your FIA, but you would have made so much money on your inflation hedges, that you would be in a much better position than just about anyone else.  And you were also prepared if things had gone a different way.  This is the kind of balance you want to achieve in your portfolio.

A Cautionary Tale

We had a client from another state who we have never met face to face.  In the process of examining what they were currently doing, we noticed a massive problem with a life insurance policy that they had previously purchased.  It was designed to crash a few years down the road, but they were unaware of this.  In going back to talk with their agent, they were convinced to meet a “financial adviser” friend of his.

This person then convinced them to put almost all of their savings into a Fixed Index Annuity.  There are only two reasons why the insurance agent would have sold them on this idea and neither is good, but since I don’t know which it is, I won’t speculate.

The important question, is why did the couple decide to go this route?  Two reasons come to mind…  One is that there was a very large bonus promised.  It’s important that you understand that a large bonus often means worse lifetime performance.  The money has to come from somewhere, right?  The other is the large guaranteed growth that we’ve previously discussed.  And that wonderful benefit is in itself a trap.  Remember that a 6 to 10% guaranteed interest rate sounds great in a zero percent world.  But it is financial death itself in a 30% + world.  It’s hard for us to imagine a world like that because we’ve never lived it, but many millions of people in the world have, and they were all sitting right about where we are now just before it happened.

The sad thing is that in this hypothetical situation, right about the time the person who owns a product like this finds out what a bad decision it was, they then learn about the Market Value Adjustment (MVA) feature that was built into their product.  This is typically not expounded upon by the salesman, but is a feature that means the cost of changing your mind could be substantially or dramatically higher than what you thought it was when you signed up.  (So either pick a company without an MVA feature, or make sure you understand it and are ok with it!)

As said before, there are some companies that offer much bigger upside potential than the products that most buy (and this couple in particular bought) which could help hedge inflation in this situation.  But you must work with an agent who is willing and able to show you the best of what is out there.

None of this is to say, don’t put some of your money into a fixed index annuity.  This is the best way possible to grow money at a guaranteed (much) higher rate than can be found in the market to ensure a lifetime income.  Just make sure that you understand exactly what you’re buying and that it fits in with other assets which more than make up for the shortcomings of the FIA.  All assets have advantages and disadvantages.  The key to a successful retirement is combining assets together in a way where each complements the other.

I’m certainly grateful to the couple mentioned above because they, in part, caused me to once again investigate the world of Fixed Index Annuities.  I was able to research the entire industry and find out which companies offered the best products for our clients.  I had not been paying attention to that world in several years and am grateful to be able to add them to a discussion with those clients for whom they are appropriate.

I’m also grateful to know this couple simply because they are such wonderful people.  Perhaps, the economy will go in the direction that this will all work out for them.  Or perhaps, it will go the other way.  Time will tell.  We believe that when you have substantial assets, it’s best not to bet on one direction or the other, but to instead devise a plan to make it through any scenario that comes your way.  That is what we try to help people do!

You can find the previous posts in this series at: 1) Innovative Insurance, 2) Long Term Care, 3) Long Term Care Solutions, 4) Free Long Term Care Insurance, 5) What is an Annuity?, 6) Immediate Annuities, & 7) Fixed & Variable Annuities, & 8) Fixed Index Annuities.

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