Index Annuities Explained

In this video, Matt Blocki from EWA discusses why EWA advises against index annuities. He points out that while index annuities promise stock market upside with no downside risk, they often come with caps on gains, exclude dividends, and involve fees. Matt shares an example where an investment tied to the S&P 500 yielded limited returns despite a strong market performance. He also mentions that insurance companies use derivatives and warns about the discrepancy between annuity and market values when taking income. Overall, he recommends exploring better investment options for a more effective and secure financial plan.

Video Transcript

Hi, Matt Blocki from EWA. Today we are talking specifically about index annuities, how they’ve gained popularity, but also why EWA as a company is completely against recommending a client invest their money in an index annuity.

So first and foremost, an index annuity has one of the greatest sales pitches that could be made out of all time. So basically, you have the upside of. The stock market, the S and P 500. Now, that’s usually capped, which I’m going to explain in a second.

And then you also have no downside. There’s a floor so we can get the upside of the stock market and we’re also not going to take risk doing so. So that sounds amazing. Obviously, people don’t like seeing their money go up and down.

But in reality, what this ends up doing is putting money from your pocket into the agent that sold you pocket and then ultimately the insurance company that’s backing it up, just due to the very complicated nature of how the index annuity works.

And we’re going to go through on a high level specifically the problems I see in the index annuities and then specifically why I would recommend not investing in these. And so the first example, we were recently evaluating a client’s index annuity that they had put about $100,000 into seven or eight years ago, it was tied to the S and P 500.

And evaluating it eight years later, their account value was $104,000. And so looking back, if you think, okay, what has the S and P 500 done in the last eight years? It’s one of the best runs it’s ever had.

So how did 100,000 not grow to 200, 300,000 if it was truly tied to the S and P 500? So here’s some of the inner workings specifically with this annuity. And most index annuities have a similar concept involved with them.

So the first thing is there is. And that four could be zero, that could be one. We’re going to assume it’s zero. And then there’s also a cap. So this one had a monthly cap rate attached to the S and P 500, which was 1.2%.

We’ve also seen cap rates that are determined annually, sometimes around 12%. It and the third thing is, and this is not something that’s typically disclosed unless you really read the prospectus, is you do not get credit for any dividends of the S and P 500.

So if you look back from 1927, the great, you know, Great Depression till today, the S and P 500, and this changes on a daily basis based upon what the stock market in general, the S and P 500 has done at about 9%.

And over a third of that return yes, a third of that return has come from dividends. So if there, in fact is no downside, if in fact you still participate in stock market returns with the exception of the dividends not being included, why was $100,000 investment only worth $104,000 over eight years?

Well, the answer is pretty simple. When the S and P 500 does well, it does very well. So, for example, there’s been some years we’ve seen 25% or greater returns. And if you’re in an instrument that caps you at 12%, for example, that just cost you 13% while you’re getting capped, also without the dividends, there are typically fees that are associated with the indexed annuity as well that are coming out no matter what the S and P 500 has done.

So in general, I would be very cautious of these type of instruments. I’m going to put some data on the S and P 500, but. Capping your S and P 500 upside at 12%. Without dividends, you’re going to miss out on more than half of the returns that would be available historically from the S and P 500.

And with anything, yes, there is going to be a risk if you invest directly in the S and P 500. But a loss is only a loss if you take the loss. And also a gain is only a gain if you take the gain. So as long as EBA sounds on financial plan, the idea of this may make you sleep at night and that’s what an insurance agent would pitch to you.

But just from every experience, these sound great on paper, but with these three factors alone, the ones that we’ve evaluated, that they’ve had clients have had for the last five or ten years during one of the hottest streaks of the stock market in history, why do they put X amount in and have very little above that?

And this, unfortunately, is why there’s fees and expenses. You’re missing out on the huge upside from the dividends. You’re missing out on the huge upside of when the market does great, it does really good, and you’re capping yourself.

And for those reasons alone, we’d always recommend to steer clear of indexed annuities separately from the cap rates. In really doing some due diligence into these contracts, we have found that the company that you’re investing in is actually using a lot of derivatives.

They’re not themselves putting their money in the S and P 500, which in itself is a red flag to us. Secondly, when you start to take income from the annuity, typically we see there’s a market value and then there’s an annuity value.

And those are two separate things. Sometimes times companies will have bonuses and guaranteed growth that occur on the annuity value. Now, what the annuity value is is it’s a value that eventually you can pull income off of as long as you’re living.

But if suddenly you pass, that is a phantom thing. What’s going to be passed to a spouse or surviving kids is the actual market value. And the market value gets affected by fees, gets affected by actual performance, and also gets affected by withdrawals.

So again, if you do an indexed annuity, again, the pitch of no downside participate in stock market returns. All of our analysis of these. If you live to the IRS’s life expectancy, late 80s, early ninety s, you take the income out and then you factor in what your kids are actually going to get, you’re going to end up with a very bond like instrument of three or 4%.

And there’s a much, much better effective way to invest and have safety nets and have a sound financial plan than putting your money into an indexed annuity. We welcome any questions, concerns, and look forward to discussing with you.

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