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Retirement Planning > Retirement Investing

Have your cake… and eat it, too

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Today many advisors are concerned about locking their clients into an interest rate that is perceived to be the lowest in recent memory. Plus, many clients may be aware how this low interest rate environment could affect their retirement’s overall accumulation. This interest rate scenario may be good for home buyers, but for those who depend on a good interest rate for accumulation and distribution of their retirement assets, not so much. So there may not be a better time to learn about and present the equity indexed annuity (EIA) to all your appropriate clients as an alternative.

Why an EIA?

So why would an equity indexed annuity be appropriate for some of your clients?

  1. Safety–An EIA could be one of the safest places for their retirement dollar
  2. Liquidity–Penalty-free access to a portion of their investment
  3. Tax deferral–Your client can pay taxes when they are ready
  4. Probate avoidance–Structured properly they pass probate free
  5. Yield–A higher return than many alternative fixed-rate investments

The only thing different about EIAs are that the returns are linked to an index as opposed to an interest rate, which means potential for greater accumulation. The principal is guaranteed. These are the benefits you could be providing to your clients.

EIAs are not designed to compete with other guaranteed-rate annuities, variable annuities or mutual funds. They are designed to fall in between those and still provide a hedge against the necessary inflation factor in retirement planning.

Crediting methods

A common crediting method is the annual reset. When the market moves forward, your client’s retirement plan moves forward. When the market moves backward (I always assume there will be a period of time when the market moves backward), their retirement plan can stop at their last gain; in other words, they don’t lose ground. Once a return has been credited to the policy (depending on the policy provisions, the crediting method and participation chosen), it cannot be taken away. There isn’t any such thing as a loss associated with this crediting strategy.

Two versions of annual reset design

  1. The point to point with annual reset crediting method. Point to point means there is a starting point and an ending point (the contract anniversary) from which the gains are calculated. For example, if a policy were issued on January 1 this would be the beginning point. The ending point would be December 31, 365 days later. From those two points the gain is calculated and credited to the policy. This strategy performs well in an upward market.
  2. Monthly average version of the annual reset design. A monthly average uses the close of the given index on each monthly anniversary; all anniversaries are added together and divided by 12 to calculate the index gain at the end of the year. A policy issued January 1 would have monthly anniversaries of February 1, March 1, April 1, and so on. The close of each monthly anniversary is added together and divided by 12. This strategy performs exceedingly well in a volatile market with many ups and downs.

Moving parts

All equity indexed annuities have at least one moving part. Moving parts allow the insurance company to keep the product competitive and help them outperform guaranteed products as the interest rate environment changes. Between 65 percent and 85 percent of the financial backing of the equity indexed annuity comes from traditional annuity investments, which are investment- grade bonds. There are three basic moving parts in most EIAs.

  1. Cap: The marketing term for this is maximum annual interest. This is the maximum amount of interest that will be applied to the contract on each anniversary. Your client is sharing the gains of the market in return for zero downside market risk. Your client makes money before the insurance company does.
  2. Participation rate: This refers to the amount of the calculated gain that will be credited to the policy. It may seem like a difficult concept to explain to your client so you may illustrate it as a percentage of the calculated gain rather than a percent of a percent. For example, (using easy numbers for illustration purposes) with a calculated gain of 10 and a participation rate of 75 percent, your client will get 7.5 percent. With a calculated gain of 10 with a participate rate of 125 percent your client will receive 12.5 percent (again I’m just using an easy number to illustrate the concept).
  3. Fees: Fees are sometimes assessed to help the insurance company cover the costs of administering policies. If a fee is present, be sure the maximum it can go to isn’t very high since it whittles away at returns each and every year it is present in the policy.

There’s a time to “sell” and a time to “tell”

When I first got in the business I learned a few selling concepts that have always stuck with me: To illustrate you demonstrate, always think in ink and ask questions that require your prospect to think and then demonstrate how their answer could be the solution for them. Questions you might ask to uncover the things that concern your clients the most and will open a door to demonstrate the best solution through an illustration are:

Are you willing to share the upside potential of the markets with an insurance company if they would guarantee no market downside in return? Many people would have much rather seen a zero last year on their retirement statements as opposed to the double-digit loss they shared with many other investors. The number may not jump off the statement like it did on a mutual fund or variable statement, but they are guaranteed to move in one direction only. Tell your client they will see at least one down year if not a couple throughout the length of their policy. A zero may be much more favorable than a negative return.

If I could offer you a product that has the safety and security of certificates of deposit and the upside potential of the markets, would you be interested? That’s as difficult as it needs to be. Inform your clients of the opportunity they have in an EIA as one of their retirement vehicles highlighting the aforementioned five benefits.

Of the money you have left, how much do you not want to have at risk in the marketplace so you can invest more confidently with the balance of your money? Helping clients develop options to meet their current and extended needs, to be able to address lifestyle issues as they age is the best practice we can perform. This question helps clients separate the portion of their money they may not want to risk while still leaving the door open for gains in their worst investment year.

This may be the lowest interest rate environment we have had in recent memory. You might want to offer the EIA as an alternative. You may be doing your client a favor by finding them the best five-year rate guarantee this year, but you may be doing them a disservice for the next four if the interest rate environment moves up from its lowest point. Ask your clients if they are willing to be married to rock-bottom interest rates or if they would rather buy in at the bottom with an opportunity to improve their situation as the market moves forward. Regardless of their choice, you offered your clients an annuity that has the benefits we reviewed and the opportunity of the upside potential of the markets without the downside risk associated with the securities markets. A zero is often more favorable than a negative return.

For more from Lloyd Lofton, see:


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