Index Annuities: Complex, Aggressively Sold Investments

In many states, all a salesperson needs is an insurance license, which many regard as being far easier to get than a securities license. Considering the tremendous sales pressure that the high commissions generate, there's a good chance you may be approached. So it's important to understand how these products work.

Things to look for include:

Penalty-free withdrawal. Some index annuities allow you to withdraw a limited amount of your initial investment each year without paying a surrender penalty. This flexibility takes some of the angst out of decisions about whether to buy one of these products and, if so, how much to invest.

Cap rates. Most index annuities come with a cap on the amount of returns you would get on your investment over a set period. If the index does better than the cap, you get the cap rate only. Insurance companies, which typically set the cap rate at levels that are profitable for themselves,

Participation rates. These call for annuity buyers to get a fixed percentage of the index's increase each year. Again, the insurance company calls the shots on this by retaining the option to reset the rate annually. Some index annuities carry both a participation rate and a cap rate. (Insurance companies take their management fees out of returns above these rates, so the amounts of these fees are extremely difficult to distinguish.)

Financial strength. When you buy any type of annuity, you're essentially lending money to an insurance company for repayment with interest (minus fees). So you need to check on the long-term financial strength of these companies to assess risk. A good way to do this is to check the company's strength rating with A.M. Best

Even if you fully understand all of the features of an index annuity, it doesn't answer the question of whether a particular product is right for you. The reason the SEC tried to regulate this product was because they are frequently sold to people for whom they aren't suitable.

All too often, people are persuaded invest every dime they have, only to regret it down the road when they need large amounts to buy a retirement home or pay bills. Or they may discover they've made choices that work against their overall investment strategy regarding taxes and interest rates.

Whether any index annuity is right for you depends on many variables, including your age, income, existing portfolio, risk tolerance and total financial picture.

So when your tax preparer — after getting a clear view into your finances from your tax return — suggests an index annuity, ask him or her for a written analysis explaining why this product would work for your situation.

If the preparer won't provide this, walk away. If he or she will, then you should analyze it, preferably with help from an independent financial advisor.

Also before buying, be sure to ask the salesperson how much he or she would get as a commission. This way, everyone understands the motivation for the sale.

Ted Schwartz, a Certified Financial Planner®, is president and chief investment officer of Capstone Investment Financial Group ( He advises individual investors and endowments, and serves as the advisor to CIFG Funds. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on achieving their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at

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