Investor Column | Indexed variable annuities look attractive

Lately, clients tell me they have concerns about the stock market sending scary signals. They are not feeling the love for Certificates of Deposits. CDs, have the virtue of not losing interest or principle because of FDIC insurance. Rates on three-year CDs are practically insulting, and they are only paying about one percent.

Freaking out about staying the course in aCOVID-19 world? No problem because what is old becomes new again. Let’s take a fresh look at Variable Indexed Annuities. They are evolving. With 30-year Treasury yields falling from 1.66% on June 8 to a new 1.19%, and interest rates likely staying low, let’s explore if purchasing a variable annuity is a smart move.

First, let’s cover some due diligence. “Variable annuities have become a part of the retirement and investment plans of many Americans,” says the SEC. “A variable annuity is a contract between you and the insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date.”

Variable annuities offer a range of investment options with underlying investments, like mutual funds or indexing strategies, affecting account value. Annuities, unlike mutual funds, accumulate tax-deferred. However, money taken from a variable annuity gets taxed at ordinary, not low capital gains, tax rates. Investments accumulate and grow tax-deferred until withdrawing funds.

Minimizing the risk of outliving assets by annuitizing, taking a stream of lifetime payments, is often advantageous. So are death benefits because, at a minimum, if you die before receiving payments. Beneficiaries typically receive -- your purchase payments if the account value is less than your death benefit.

If you own these investments outside of an IRA, individual retirement account, you gain tax-deferral, allowing you to postpone paying taxes. Understand, however, traditional individual retirement account, and a 401k also offer opportunities for tax deferral. Mutual funds usually provide lower costs than annuities, but do not offer annuity income and death benefits.

Annuities have fees, though. Remain in investment long enough to avoid surrender charges. Surrender charges within a period, quite often six to eight years, is a type of sales charge. Usually, you can withdraw 10% of your investment without incurring surrender charges. Always consider investment risks and read prospectuses. The issuing company’s ability to pay claims backs annuity contracts, rider guarantees, and annuity payout rates.

Investing choices help you accumulate funds for retirement and affect the amounts received at retirement. Note some variable annuities do not allow taking money from accounts once you start receiving regular, annuitized payments.

People are often finicky, somewhat irrational, in my opinion, when comparing annuities and bonds. Underperforming bonds, instead of an appropriate annuity may ironically provide some people who are not fans of annuities, with less income and distributions. Guarantees offered, for a fee, by the annuity company isn’t available with mutual funds.

Other annuity costs include mortality and expense, usually at the cost of about 1.25%. There are also administrative fees, for record-keeping, and additional charges for stepped-up death benefits, long-term care guarantee, and guaranteed income benefits.

Okay, let’s consider protecting some of your nest egg from market downturns, like possible election chaos or another bad wave of COVID-19. Downside protection from an Indexed Variable Annuity might allow you to worry less. Think of it as your seatbelt for a wild ride.

I have got my eye on the new Index Advantage Income Variable Annuity from Allianz. There are other companies, of course, but for simplicity, let’s discuss some exciting features with its Index Performance Strategy. Features include investing potential, protecting levels to minimize or avoid losses, and lifetime income payments. Another advantage is that Allianz fees are much lower than traditional annuities; product fees, as described in the prospectus, are 1.25% a year, not the customary 3% of some annuities.

Benefits allow you to avoid some, but not all loss, when the stock market drops. It comes with a three-year term index crediting point to point using the S&P 500 or the Russell 2000*. Performance credit is equal to a return, up to a cap. Be careful, though, you can lose money allocated on index options, and your loss may be significant.

Long-term performance offers growth potential, but it is not guaranteed. It also comes with a level, called a buffer, protecting from some index losses. There is a buffer offering downside protection of 20%. So, if the market drops 18% in a year, you are covered. There is no erosion of your account. What if the market loses 25%? Your account declines 5%, not 25%, because of the protection features.

Choose between an uncapped S&P 500 Index and a 60% cap on the Russel 2000 Index for, hopefully, building gains in the three-year term. The Performance Strategy, described in the prospectus, also offers a 20% “one-year” performance cap on the S&P 500 with a downside buffer of 10%.

For those wanting more balance, Allianz also offers an Index Protection Strategy offering principal protection with the potential for some growth. Take the S&P 500 index, for example, and the amount would be approximately 2.8 percent with S&P 500, Russell 2000, and Nasdaq-100 Indexes. The buffer on the downside of the Allianz Index Protection Strategy is 100%. So, if the market index does zero, you get a set rate of 2.8 percent.

With all the weird stuff in the world, the variable indexed annuity may be a prudent alternative to owning more volatile investments. Variable indexed annuities, not insured by the FDIC, may allow earning more money than a CD and allow you more room to maneuver markets. Using asset allocation and increasing diversification do not always ensure making a profit or protecting yourself 100% from investment losses.

Investing in variable indexed annuities are not right for all people and all circumstances. Get professional advice, far beyond this column, from a knowledgeable financial advisor. The value of a contract ultimately depends on how indexes perform and selection of investment options.

Examples given are for illustrative purposes only, and the return is not indicative of any actual investment. Actual investment results may differ substantially. Comparisons to major indices are for illustration purposes only. It is not possible to invest directly in an index.

You should consider the investment objectives, risks and charges, and expenses of the variable annuity and its underlying variable annuity investment options carefully before investing. The prospectuses for the variable annuity and underlying variable annuity investment options contain this and other information. A prospectus can be obtained from your financial consultant. Read the prospectuses carefully before investing.

Jim Germer is a Bradenton CPA and financial adviser at 100 3ThirdAVE W., Suite 130. Call (941) 746-5600 or email jim.germer@ceterafs.com. Securities offered through Cetera Financial Specialists LLC (doing insurance business in CA as CFGFS Insurance Agency) member FINRA/SIPC. Advisory services offered through Cetera Investment Advisers LLC. Cetera entities are under separate ownership from any other named entity.