Wha’choo talkin about?


An attractive investment product that many are talking about is the guaranteed fixed index annuity or FIA. With the market collapse of 2008, along with the recent completion of the worst quarter for stocks since 2011, fixed indexed annuities are arguably in more demand than ever. When we own a guaranteed FIA, we are essentially handing our money to an insurance company creating a contract between the insurance company and us. In return, we receive a guarantee that we will receive our initial investment, at a minimum, at the end of the term. In addition, we will receive yearly tax-deferred interest based on the performance of an index such as the S&P 500 up to a limit (cap rate). Please understand that there is not just one type of FIA. There are hundreds of FIAs to select from, all with many different moving parts.

Tony Robbins, author of Money: Master the Game discusses in his book, the “upside without the downside” risk regarding fixed index annuities. This upside/downside unregulated sales pitch is unfortunately used far too often, and it is not entirely accurate. Yes, the FIA owner has no downside risk, but they still can lose money! I can hear your mind verbalizing the legendary catchphrase from an episode of Different Strokes, when the puzzled Arnold Jackson would utter, “Wha’choo talkin’ ‘bout Willis?” Please hang with me for just a little longer as I connect the dots and explain this stuff for you.

I suggest that anyone would love to own an investment that provides upside potential of the stock market with no downside risk. However, as an avid reader of this column, you know how critical it is to employ our nonsense filters when we get pitched a perceived to-good-to-be-true idea. Our baloney screens remind us to remain skeptical, keep asking questions, and maintain both hands on our wallet or purse. While there are no fees for a simple and straightforward FIA, there can be charges if we yank our money out too soon. For example, if we take out money or terminate our FIA before the contract period, most insurance companies will levy a surrender charge. Therefore, we are only guaranteed not to lose any money if we hold the FIA for the term of the contract. Now, do you see how one can lose money but have no downside risk? Regrettably, far too many advisors ignore this small but significant FIA feature. It is worth noting that most insurance companies allow us to withdraw 10% of our principal each year without any surrender charges. Another noteworthy feature that is frequently not mentioned to the client is that the insurance company has the option to change the rules of the FIA contract at their discretion on how they credit our interest. Perhaps, the omission of certain critical facts is the reasons that FIAs are subject to numerous alerts and bulletins from a variety of concerned regulators. For example, FINRA, the independent securities regulator, noted that FIAs were “anything but easy to understand”.

This is how I see FIAs; guaranteed fixed index annuities are not bad, people are bad at explaining risk/reward features. The debate over the good and evils of FIAs is no fault of the product itself. It is more the fault of the financial system and some of the advisors that promote these products. Perhaps this is why AARP Magazine ran a scathing article about FIAs in their May 2014 issue titled, “Don’t Buy It “with a picture of Leonardo DiCaprio, star of the movie The Wolf of Wall Street. In the film, DiCaprio plays a dishonest, immoral, and unethical investment banker. As in every profession, while there are some wolves, there are also many trustworthy advisors, who are advising clients to include FIAs in their portfolios. Of course, FIAs are not appropriate for every investor, but they do have their place and can be a nice complement to help create a well-diversified portfolio. In the end, increasingly more investors do not mind locking up some of their safe money to earn potentially above average rates in exchange for no risk to principal assuming you hold the investment to term and avoid taking withdrawal above what the FIA allows) and significantly less volatility in returns. Perhaps it is like having your cake (some of the stock market gains) and eating it too. Should you have questions regarding FIAs or any other financial matter, feel free to drop me a line or give me a call.

Prior to purchasing a FIA check with your Financial Advisor to see if a FIA makes sense for your situation. Please note that Indexed annuities can be expensive and have been known to have substantial surrender charges if you surrender the policy early, and you may incur a tax penalty that could reduce or eliminate any return. The surrender period is the time which you must wait to take withdrawals from your annuity to avoid a penalty. The surrender period and penalty differ by annuity.Wells Fargo Advisors is not a tax or legal advisor.

Fixed annuities may have a higher initial interest rate which is guaranteed for a limited time period only. At the end of the guarantee period, the contract may renew at a lower rate.

Guarantees are based on the claims-paying ability of the issuing insurance company. Guarantees apply to minimum income from an annuity; they do not guarantee an investment return or the safety of the underlying funds

Insurance products are offered through our affiliated nonbank insurance agencies.

The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. The opinions expressed here reflect the judgment of the author as of the date of the report and are subject to change without notice.