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.