Beware The Equity Index Annuity

With the stock market so scary right now, investors are looking for a sure thing, especially those approaching or in retirement. Enter the equity index annuity, which promises you’ll never lose money but if the index it’s tracked to, like the S&P 500, gains, you’ll get some of that. Though your maximum upside is capped and you have to agree to keep your money in there for a fixed term or suffer stiff early-withdrawal penalties. Annuities are infamous for being extremely complicated and festooned with bizarre fees, but, that aside, NYT Your Money reporter Ron Lieber analyzed a typical equity index annuity and found it was a bad bet. Here’s how the numbers played out…

Testing it under a variety of historical models, doing a combo of zero-coupon T-bonds and the rest in a low-cost index fund beat equity index annuity funds at least 19% of the time. More specifically, Ron Lieber writes:

Let’s say you have $10,000, and you don’t want to lose a cent of it. You could take just enough of that money and buy zero-coupon Treasury bonds that will be worth $10,000 in 10 years, thus guaranteeing you’ll get your principal back. Then, you could plop the rest in an S&P 500 index fund (to get some of that same upside the index annuity promises).
How might that work out for you 10 years from now? In a simulation examining 50,000 different outcomes using the same sample annuity I described in the backward-looking comparison, and assuming an annualized S&P 500 return of 10 percent (7 percentage points from capital gains and 3 percentage points from dividends) the bonds-plus-index-fund strategy beats the index annuity 81 percent of the time. Take that presumed return up to 13 percent, and the index annuity loses 92 percent of the time.

Weighing an Investment That Promises No Risk [NYT]

(Photo: Earth2Kim)