We all know that interest rates are low, which means that your rates on bonds, bank CD’s, or any other fixed-income investment are also low. Investors are reaching for anything that might improve their current return. One such “reach” that is being heavily promoted by the insurance companies that issue them is an Indexed Variable Annuity. If you have seen any of these promotions and are considering a purchase of an Indexed Variable Annuity, my advice is: Beware!

Annuity

I say Beware because you at least have to understand all of the vocabulary of this part of the investment world and how each word relates to your money and your investment. An Annuity is a steady stream of income over a period of time. Typically the income stream is fixed, and therein lies one issue with an indexed variable annuity: Its income stream is not fixed.

Variable

Having dealt with the noun in this type of investment, let’s move to the adjectives. Variable means just that – not fixed. The owner of a variable annuity doesn’t know for sure what the income stream will be, at least for a period of time, based on the type of variable annuity it is. This isn’t necessarily a bad thing; just different than traditional fixed annuities. If you can deal with the uncertainty of the variable payout rate, then the investment could work for you. The current return of variable annuities depends on the performance of a portfolio of securities (usually mutual funds) that the issuer (typically an insurance company) invests in. A variable annuity will often have a “floor” return that provides the annuity holder some safety, but your principal can be at risk when you invest in a variable annuity. Current returns of such investments are difficult to search and find on the internet – a lot different than traditional bond rates or dividend rates of stocks.

Indexed

The second adjective means that the annuity’s return is tied to a major stock index, such as the S&P 500 index. Often there is a provision such as your return will be no lower than 0% (i.e., you don’t lose money) and will be up to 70% of the performance of the S&P 500 index. That may sound like not such a bad deal, but the return is variable, not fixed; your money will be tied up in the investment for the long term and it may be difficult to get your money out if you need it; and there are high fees.

Other Vocabulary

Other terms you need to be comfortable with if you consider an indexed variable annuity:

• Term Cap: The most you can earn during a given term, usually a number of years, and usually expressed as a percentage (such as 70% in my example above) of the underlying index.
• Participation Rate: The percentage rate of return that you earn, up to the expressed Cap.
• Trigger: If the underlying index has a positive return for the year, that “triggers” participation in that return for the annuity holder.
• Floor and Protection Level: If the underlying index goes down, the insurer will “eat” the loss up to a certain floor amount. Sometimes the floor is 0%, but other times it may be a negative number, meaning you as the annuity holder could lose money.

IMO

Indexed Variable Annuities are complicated, and it is said they are “sold” rather than “bought.” Go ahead and Google “Rates on Indexed Variable Annuities”, and you will not see a percentage rate that is easily explainable or comparable among different issuers. The current returns on traditional fixed income investments are low, and you may be looking out there for alternatives. Unfortunately, I don’t see the upside of owning an indexed variable annuities as commensurate with the downside of owning such an investment. That said, it may work for you, but at least make sure you understand what you are getting yourself into. Contact me if you think I might help.