The origins of the annuity contract can be traced back to Roman times. In the United States, annuities gained traction in the 1930s primarily because of the Great Depression. Over the years, individuals have purchased annuities for a variety of reasons, such as, tax deferred growth, guaranteed retirement income and safety. Regardless of the specific reason, many individuals hold annuities as part of their total investment strategy; therefore, it is necessary to regard them in the same manner as traditional investments, such as, stocks and bonds.
Assume an annuity investor purchased a $100,000 single-premium deferred fixed annuity in 1989. A typical average return for a fixed annuity over the past 20-year period was 5.5%, annually. At this rate, the annuity would have grown to $291,776 by 2009. As a safe, fixed income investment, the annuity performed well, especially considering the tax deferral benefit. However, over the same time period, the Standard & Poor’s 500 Index posted an average return of approximately 7.5%, annually, inclusive of reinvested dividends. Considering that the long-term average return for the S&P 500 is approximately 10% annually, the past 20 years has been significantly below historical norms. An optimistic investor might expect future S&P 500 returns to be equal to or greater than the historical average. However, a less optimistic investor might have the opinion that the past 20 years is a good indication of what to expect going forward, thus signaling future S&P 500 returns to remain significantly below historical norms.
Since predicting the future with any certainty is impossible, deciding whether the next 20 years will produce above average or below average returns is a difficult decision. With the current low interest rate environment, fixed income investors have little chance of receiving attractive returns in the near term. Since you already own a fixed annuity, it is fortunate that insurance companies have an annuity product, the equity index annuity. Equity Index Annuities are effective at balancing the issues of equity market uncertainty and low interest rates. Although the product has been around since 1995, now is quite possibly the most intriguing time to consider this product, because of the low interest rate environment coupled with the statistical likelihood of above average equity returns over the next 20 years.
Generally, the way an equity index annuity works is the annuity holder will receive an annual interest crediting, subject to a predetermined cap, which is based on the performance of an equity index such as the S&P 500. However, if the equity index posts a negative annual return, the annuity value does not go down. Instead, it retains its value, and a new cap is determined for the next year. The effect is that the annuity holder can benefit from equity-like returns with the certainty that the annuity will not lose value.
As a reminder, Henssler Financial believes that any money needed within 10 years should be invested in fixed income securities, and any money not needed within 10 years should be invested in high quality, individual common stocks or mutual funds that invest in common stocks. As such, if you do not need the money in your fixed annuity in the next 10 years, you may want to consider this strategy. However, if you need this money in the next 10 years, you may want to consider leaving the funds in the fixed annuity.
If you are interested in converting your old fixed annuity into an equity index annuity via a 1035 exchange (necessary to retain the tax deferred nature), or for other ideas to maximize the benefits from a fixed annuity, please contact Henssler Financial at 770-429-9166, or [email protected].