A new client of mine asked me to evaluate this situation. Last year, a so-called “financial advisor” who was actually an insurance agent got them to transfer all of their money from TSP (a fantastic retirement plan for federal employees) into an equity index annuity with an insurance company. 

The selling points often presented by these “advisors”  for products like these are that an index annuity can save them taxes and that the money is protected from market drops and will never go below its original value. The first selling point is bogus in this case! Since the money was in TSP where money grows tax-free anyway. The second selling point appears on the surface to be valid, but it is also bogus as I will show you in a moment. 

Equity Index Annuities (as well as Equity Index Life Insurance) are a product heavily pushed by insurance companies at financially unsophisticated folks. Supposedly the product allows your money to increase with a market index, but when the market index falls, your money never goes lower. It almost sounds like a charity, doesn’t it?  The insurance companies let you take the upsides and they absorb the losses. But do they? What’s the catch?

Let me try to list ten …

1. They take your dividend yield. Here they use an index, usually the S&P 500, to calculate how much to credit to your account. But since the index level does not include dividend yield, unlike holding an index fund directly, you’re giving up on average 2.3%, the medium dividend yield of the S&P 500. To put it another way, in 10 years, you will give up 23%; in 20 years, you will give up 46% of gains that should belong to you. And you give that up without even knowing it since you don’t know the index level does not include dividend yield.
2. So they take your dividends, but at least they protect you from the downside right? Wait, there is a surrender period, and if you want to take your money out within the surrender period, you have to pay a surrender charge. For my new clients, the surrender period is 14 years! The surrender charge is 20% for the first 2 years, and still 18% after 5 years, slowly going down to 10% after 10 years. If you put your money into this product and need to take it out next month due to an emergency, you lose 20% right there. What kind of downside protection is that?
3. But they at least give you all the market upsides right? Nope. They have multiple ways to take away your market upsides, each one worse than the other. Let me explain four keywords that signify how they take away your money: cap, participation, average, and guaranteed minimum.
4. The most generous way, meaning they take the least of your money, is the so-called “point-to-point cap index” account. Usually an account like that will credit your money subject to a cap. The initial cap could be 10%, meaning that if the index goes up 13%, you will still get only 10%. Historically, the S&P 500 has gone up more than 10% about 50% of the years. So right there you are giving up any upside above 10%. 
5. But wait, the cap is only an initial cap.  One year later, the insurance company has the right to change the cap, but they guarantee the cap will not be less than 1%. This is the so called guaranteed minimum cap! So after one year, if the market goes up 20%, according to the contract, it is entirely legit according to the annuity contract for them to take 19% of the 20% and give you only 1%.
6. The second type of account is the so-called “participation index” account, which has no cap – Hurray! But they get you in another way – that is index participation. For example, if your initial index participation is 30%, you only get 30% of the index gain! That is, if the market goes up 10%, you only get 3%!
7. The initial participation rate only lasts for one year. After the first year, the insurance company can give you a new participation rate, which they guarantee to be no less than 10%. If the market goes up 9%, you get 10% of the 9%, which means, you get a whopping 0.9%! 
8. Now imagine they give you an account that combines these two features! This particular insurance does not, but others do. 
9. Don’t get me started on the “average index cap” account and the “average monthly index cap” account. They are even worse than the above two!
10. I need to take a breather. 

If you also have an equity index annuity, schedule a 2nd opinion review with me. I will explain to you what you don’t even know or understand about your contract. As a side note, this type of product is not under any federal regulation. It’s all the more important for you to understand what you signed up for. 

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