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)


Edit Your Comment

  1. Snarkysnake says:

    This is a timely article.

    There’s some goober pitching these things on the radio here where I live (Chattanooga area)and the first time I heard his pitch,my bullshit detector went off the scale.He’s purposefully vague about how you can get all of the upside of the stock market with none of the downside. Can’t be done. This is the ultimate Roach Motel investment. If there is a way to make annuities any worse,this is it. The fees and charges are fucking ridiculous.

    Stuff like this is why you should use insurance companies for insurance and investment companies for investments.

    • Tux the Penguin says:

      @Snarkysnake: Its especially sick now that the market has lost all that value, this is when you don’t want to cap your gains.

      If you had one before the collapse, you’re doing pretty well. But you need to look at the fee schedule to see how bad they hit you.

      I’m sure there is a legitimate market for these instruments, but its probably not the wide market that they try to make it seem.

  2. rtac5b says:

    Just do it yourself with a bull spread.

    • catcherintheeye says:

      @rtac5b: Seriously? If people are confused about whether an equity index annuity is a good or bad idea, I doubt they either a) even know what a bull spread is or b) have the capital or experience to being trading in options.

  3. RevRagnarok says:

    Forgive me if this Q is “ignant” but why not leave it in something like a Roth and then pick up QQQQ? This seems like a much different thing to me.

  4. Trai_Dep says:

    That’s because they don’t have a moneycats running the shop, as gods (and the picture-taker) intended. Besides, when was the last time that a cat asked for $700 billion?

    Pathetically boring but true: index funds, diversification and, in times like these, faith in the long-term growth of the markets. (gulp)
    And some play money, just for fun.

  5. Elcheecho says:

    quote says: “the bonds-plus-index-fund strategy beats the index annuity 81 percent of the time.”

    summary says: “combo of …T-bonds and … index fund beat equity index annuity funds at least 19% of the time.”

    Not the same thing.

  6. Anonymous says:

    Beware. Be very informed. Several years ago I had a client interested in a Conseco index annuity. t had a 15 year 15% cliff surrender charge! (i.e. you pay 15% to get out until 15 years have gone by).

    I told her that there were only two reasons someone would offer that type of product: one – it was the very best investment ever invented and no one ever wanted to quit making money with it, or two – they made it so painful once you found out how bad you’d been screwed that you couldn’t afford another 15% hit.

    You Decide.

  7. CumaeanSibyl says:

    Is that Tax-and-Spend Cat?

  8. Segador says:

    I just don’t trust this cat’s opinion as much as I would Captain Duvel Moneycat’s.