For a product that once was about as plain vanilla as a financial instrument could get, the fixed annuity is proving to be surprisingly controversial. Utility isn’t the issue; advisors continue to tout fixed deferred annuities, both the traditional kind and its younger cousin the fixed index (or equity-indexed) contract as legitimate products that merit use in a variety of applications.

Indeed, when the right situations arise, advisors such as Richard W. Stumpf, CFP, John Freiburger CLU, ChFC, CFP, and Samuel Gott, CFP, say they’re open to recommending a fixed annuity to their senior clients. But when it comes down to their individual product preferences, the three advisors part company.

Stumpf, principal at Financial Benefits Inc. in Wichita, Kan., concedes that some fixed index annuity products are “junk” but that others, with the right mix of features, are well-suited to certain clients, despite the black cloud that continues to hover over them amid charges of shifty products and slippery sales tactics. “I think it’s a legitimate product when used appropriately,” he says. “Unfortunately, some companies know they have junk products and so do the agents who sell them. If they keep it up, they’re going to kill the golden goose.”

That goose long ago lost its luster for Gott, who contends that indexed annuities aren’t suitable for the kinds of senior clients he serves, due to the confusing and potentially disadvantageous provisions embedded in some products and the questionable tactics used in some quarters to sell them. “Frankly, I think they’re a rip-off and there is going to be a lot of litigation because there’s been so much flagrant abuse by salespeople,” says Gott, whose practice is based in San Antonio, Texas.

Instead, when the situation calls for a fixed product, Gott says he turns to a traditional fixed annuity. “Where a client is risk-averse and is looking for absolutely the most safety for the money, a fixed annuity works well.”

Somewhere between the two camps sits Freiburger, principal at Partners Wealth Management in Naperville, Ill., who says he’s willing to use either fixed product – and sometimes both together in the same client portfolio. In one such case, a couple wanted to restructure their $2 million portfolio. Ultimately, they endorsed Freiburger’s plan to put some assets in an institutional money management account, some in a traditional fixed annuity and some in a fixed index annuity. “They get more aggressiveness and sophistication with the institutional account,” he explains, “The [traditional] fixed annuity gives them a guaranteed return from a highly rated insurance company and the [fixed] index annuity gives them a floor, with some upside potential on top of that.”

Situations such as that aside, the overall appeal of fixed annuities appears to be waning. According to Beacon Research, which tracks the annuity market, indexed annuity sales in 2006 were down about 7 percent from 2005. The sales drop-off for traditional fixed deferred annuities was even sharper in 2006, at 13 percent, according to Beacon. And the decline continues here in 2007. Sales of fixed annuities, including indexed and traditional fixed contracts, in the first quarter of this year decreased 17 percent from the previous quarter, according to Beacon, and 18 percent from first-quarter 2006.

Yet even advisors like Freiburger who aren’t shy about using highly complex investment instruments say the no-frills fixed annuity still holds an important place in the advisor’s arsenal of financial instruments.

Traditional fixed annuities, he says, are best suited to clients seeking the “sleepability factor”- a guaranteed rate of return. They appeal to those kinds of investors because they offer several things an alternative investment such as a CD does not, namely tax-deferred growth and protection from probate and creditors in some states. Further, annuity income doesn’t count toward calculations for Social Security benefits. With those features, a fixed annuity doesn’t necessarily need to beat the yield offered by a CD to be a worthwhile investment, says Gott.

While shopping for a book-value fixed annuity is a straightforward exercise, Freiburger says, there are several factors to consider in comparing products. One is contract length. In the current low interest rate environment, he favors contracts with a short duration -typically three years. The more highly rated the carrier, the better, he adds. “I don’t venture too far from the most highly rated insurance companies.” As for returns, Freiburger says rates in the 4-5 percent range are adequate in today’s environment, though clearly not compelling enough to lock in for the long term, given the strong likelihood interest rates will normalize.

Investors who want a chance at higher returns than those promised by traditional fixed annuities and who are willing to assume more risk in order to get it may be strong candidates for an indexed annuity, contends Stumpf. While indexed annuities aren’t for everyone, they work well in some senior portfolios, as an alternative to bonds, CDs and the like, Freiburger says. “For a piece of some portfolios, they fit very well.”

Because indexed products offer a minimum guaranteed interest rate that is linked to a market index, investors get the security of a floor underneath their investment, plus the higher ceiling that comes via linkage to the equities market. They’re designed for clients who want the best of both worlds, Stumpf says. “It gives them the potential for higher returns than those of fixed instruments, without being directly invested in the stock market. A client who is afraid of putting money in stocks might be comfortable putting it in an indexed annuity instead of just parking it in a CD.”

Like traditional fixed contracts, indexed products offer tax-deferred growth, in addition to probate and creditor protection. Those features, plus greater upside potential, were what recently prompted a client of Stumpf’s to move $150,000 from a bank CD earning 3.8 percent into an indexed annuity offering a guaranteed minimum rate of 3 percent. “I sold it as a CD alternative,” he explains. “I showed the client that she’s going to get returns somewhere between 3 percent and 7 or 8 percent with this product.”

Evaluating indexed annuities is not an exercise to take lightly, cautions Stumpf. As an advisor, “you must understand the product,” no easy task given the highly nuanced distinctions between one carrier’s contract and another’s.

The potentially confusing nature of fixed index products is enough to keep Frances Twiddy, CFP, from using them. “There’s a perceived degree of difficulty and a lack of transparency that kind of warns you off the product,” says Twiddy, who runs an advisory practice in St. Clair Shores, Mich.

While acknowledging that fixed indexed products can be confusing, Stumpf and Freiburger say they’ve been able to identify products with the right combination of traits and track record. In general Freiburger says he prefers contracts underwritten by top-rated carriers that have as few moving parts as possible and whose contract terms are stable and predictable. He avoids using contracts that offer excessively high commissions, because those tend to be the ones with the least favorable terms for clients. Factors such as surrender period, surrender charge percentage and participation rate weigh heaviest in Stumpf’s evaluation of fixed index contracts. He looks for surrender periods in the 7-10 year range, surrender charge percentages in the neighborhood of 10 percent and participation rates of at least 50 percent. He also favors products with high historic renewal rates, which tend to indicate a higher level of customer satisfaction.

In the end, says Freiburger, the better the client understands a product, the more satisfied they tend to be with it. “My biggest concern with the indexed annuity is that clients understand what it is we’re getting into. You have to spend time explaining it on the front end, then spend time with them on delivery and on an ongoing basis so they understand how it’s working.”

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