Fixed Index vs. Variable Annuities

by

The Annuity Reporter

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Lifetime income riders on annuity products are becoming increasingly more popular and relevant given today’s economic climate and the sheer number of people approaching retirement. I don’t know the exact percentage but the majority of newly issued fixed index and variable annuity contracts carry a provision for guaranteed lifetime income.

The reason? Consumers are happy to know that a check is guaranteed to arrive each month during retirement regardless of how the market performs. Anyone who invests in the stock market has been burned at one point or another. For the average investor, it happens more frequently as most people don’t have the time or expertise to apply technical analysis to retirement planning. In reality, many pros have trouble as well.

When we’re talking about legitimate guaranteed income products, consumers need a viable source of quality information. Why? Potential consumers are likely to be given only one option from most advisors that recommend these products. That doesn’t mean you’ll get a bad deal but it does mean there might be a better deal out there.

Let’s get down to business…

There are currently two major players in this market, companies who offer fixed index annuities and companies who offer variable annuities. The product you ultimately choose will depend entirely on personal preferences.

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Here’s how variable annuities work

Since a variable annuity gives the opportunity for full market participation, you will be invested in a combination of mutual funds and bonds for the most part. In exchange for full growth potential, you will also carry the risk of loss of principle. You know how that works. That’s where the GLWB comes in. It doesn’t matter if the market tanks, a minimum level of income is guaranteed and that level of income can increase if the market does well over time.

Variable annuities carry additional fees to account for the insurance protection provided. When charges for company expenses, asset management and the income rider are tallied you’ll be looking at no less than 3.5% in today’s environment.

As for the guaranteed lifetime withdrawal benefits, the level used to calculate income payments increases annually. It is typical to see annual increases, or roll-ups as they are called, to hover in the neighborhood of 5%-6%.

When it comes time to take income, you will receive income from the GLWB balance or the account balance, whichever is greater. Payout rates will start around 4% at age 60 and usually increase by a half percent for every five or ten years you wait to take income. Downward adjustments to the payout rate will be applied for joint contracts.

Remember, this is a general analysis of what’s available in the current market. Each variable annuity contract will be

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slightly different.

Here’s how index annuities work

With a fixed index annuity you get partial market participation in exchange for a principal guarantee. Your upside growth is limited but there is no downside. Let’s not forget that this is essentially a fixed annuity where the insurance company buys a portfolio of bonds and credits the account with the interest earned on that portfolio. With an index annuity the growth is based on purchasing index options with the annual interest earned from the bond portfolio. So growth in an index annuity contract is subject to an external market index but the principal is stuck in bonds so no loss of principal can occur. Please refer to the Fixed Index Annuity Report for more details on how this works.

Index annuities use various means to price each contract including cap rate, participation rates and a spread. This is also discussed in further detail in the Fixed Index Annuity Report. As far as fees go, income riders usually cost about .75% annually on most contracts.

The income benefit also is guaranteed to increase annually with index annuities. That’s where the major benefits to index annuities start; with the annual roll-up on the guaranteed lifetime withdrawal benefit. These rates are currently running at 7%-8%.

Of course with this product type, you’ll also be planning on

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taking income at some point. It works the same here as with variable products. Income will be based on a percentage of the account value or guaranteed lifetime withdrawal benefit, whichever is greater. The benefits continue here with payout rates generally starting about .5% higher than variable annuities.

Why are Index annuities more competitive?

Yes, there is no comparison between index and variable annuities for purposes of guaranteed future income. The reasoning is simple.

Variable annuities are backed by an unstable asset base that is constantly fluctuating. This makes it difficult for an actuary to price. Because of the volatile asset base, future projections come with a great deal of variance. As a result, guarantees need to priced very conservatively.

Index annuities carry high-grade bonds for an asset base. Future projection are then much easier to price because the principal investment is exposed to little or no risk. In turn, the company can offer guaranteed income rates according traditional variables like principle, mortality and interest rates. Insurance companies have nailed that calculation for longer than any of us has been around. When an unstable variable is added to the equation, the guarantees take a hit.

How To Choose Which Product

My advice is to always take the highest guarantee available. Honestly, that’s what annuities are all about. But that means

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everyone would always take the fixed index annuity if given the option. I certainly don’t think that should be the case. There will always be people who want to be active in the market. Because variable annuities offer unlimited growth potential, the risk of loss is worthwhile to a certain class of investor.

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