Retirement Income Visions

How Will a Premium Bonus Affect a Fixed Index Annuity’s Value?

Two weeks ago, we began a series, 8 Questions to Ask Yourself When Analyzing Premium Bonuses, when considering the purchase of a fixed index annuity ("FIA"). The first five questions were answered in the last two weeks' posts. This week, we answer question #6: How will a premium bonus affect my contract's accumulation value?

As we learned in 8 Questions to Ask Yourself…, a premium bonus increases the value of a FIA by a fixed percentage of your initial year, and potentially subsequent years' investment amounts at no cost to you. As such, it gives your FIA a "kick start" that it wouldn't otherwise have without a premium bonus.

So why wouldn't you purchase a FIA with a premium bonus? There are basically two reasons: (1) Potential longer terms, and (2) Potential lower cap rates

Potential Longer Terms

For one thing, FIA's that offer premium bonuses generally have a longer term than those that don't. Longer terms result in exposure to surrender charges for more years than FIA's with shorter terms. This isn't typically a consideration if you purchase a FIA with an income rider and aren't planning on withdrawing income for a number of years. On the other hand, if you don't purchase an income rider and want to take partial or total withdrawals, surrender charges are an important consideration.

Let's take a look at the offerings of my life insurance agency to show you the affect of the presence or absence of a premium bonus on the term of a FIA. My agency currently offers a total of 47 FIA's from 13 of the highest-rated life insurance companies. Some of the FIA's have multiple configurations, resulting in a total of 62 offerings. The term of each FIA ranges from five to fifteen years.

26 out of the 62 offerings, or approximately 42%, have a premium bonus ranging from 3% - 10% with one at 20%. The shortest term is five years for one FIA paying a premium bonus of 5%. There are four FIA's with a term of eight or nine years paying premium bonuses of 3% - 5%. The vast majority of FIA's paying premium bonuses have a 10-year term, with 17 of 26 premium bonus FIA's, or 65%, falling into this category. The bonuses of these 17 FIA's range from 3% - 7%, with one offering 20%.

Potential Lower Cap Rates

In addition to a longer term for the majority of FIA's offering premium bonuses, it's also common to find lower cap rates on FIA's offering premium bonuses vs. similar products not offering them, all else being equal.

While, as previously stated, a FIA with a premium bonus enjoys the advantage of an accumulation value "kick start" vs. a FIA with no bonus, this advantage can potentially be offset in the long run by lower cap rates.

As a result, the accumulation value of a FIA without a premium bonus, all else being equal, may exceed the value of a FIA with one over many years. Every situation is different, with the actual experience dependent upon the amount of the premium bonus vs the cumulative amount of actual interest credited.

In summary, FIA's with premium bonuses generally have longer terms and lower cap rates than similar products that don't include a bonus feature. As an example, one of the more competitive, well-known FIA's offered by my life insurance agency offers the following two versions of an otherwise identical product:

1. 7-year term, no bonus, and annual point-to-point caps of 3.25% or 3.5% depending upon the index selected
   
2. 10-year term, 5% bonus, and annual point-to-point caps of 3% on all indices.  

As you can see, the tradeoff for the 5% premium bonus is a three-year longer term (10 years vs. 7 years) and 0.25% - 0.50% lower annual point-to-point cap rates.

What’s a Reasonable Premium Bonus Percentage?

Last week's post, 8 Questions to Ask Yourself When Analyzing Premium Bonuses, introduced a series of questions when considering the purchase of a fixed index annuity ("FIA") with a premium bonus. The first three questions were answered last week.

This week's post addresses questions #4 and #5, dealing with premium bonus percentages as follows:

1. What percentage should I expect to receive?
2. Why not purchase the product that offers the highest percentage?

8 Questions to Ask Yourself When Analyzing Premium Bonuses

Last week's post, Contractual vs. Situational Fixed Index Annuity Income Calculation Variables, classified each of the ten fixed index annuity ("FIA") income calculation variables introduced the previous week into two categories -- contractual and situational. The first contractual variable, premium bonus availability, is the subject of this week's post.

Contractual vs. Situational Fixed Index Annuity Income Calculation Variables

Last week's post, 10 Fixed Index Annuity Income Calculation Variables, introduced ten potential variables that are used to calculate the income, or lifetime retirement paycheck ("LRP"), amount that you will receive when you purchase an income rider with your fixed index annuity ("FIA").

It's important to emphasize that all ten variables won't apply in every situation. Six are contract-dependent and four are situational. Situational variables, by their nature, occur after the fact, and, as such, often cannot be anticipated when deciding which FIA(s) to purchase. Having said this, each variable needs to be taken into consideration by a retirement income planner when analyzing and selecting FIA income riders and products that may be appropriate for a particular situation.

10 Fixed Index Annuity Income Calculation Variables

The last five weeks' posts have focused on what you don't receive (Your Fixed Index Annuity Income Rider – What You Don't Receive – Parts 1 and 2 and Annuitization Tax Treatment of Nonretirement Distributions) and what you do receive (5 Things You Receive From a Fixed Index Annuity Income Rider – Parts 1 and 2) when you purchase a fixed index annuity income rider.

As stated in Part 1 of 5 Things You Receive From a Fixed Index Annuity Income Rider, there are three types of fixed income annuities that offer lifetime income payments: (a) single-premium immediate annuities, or "SPIA's," (b) deferred income annuities, or "DIA's," and (c) fixed index annuities, or "FIA's."

5 Things You Receive From a Fixed Index Annuity Income Rider – Part 2 of 2

Part 1 of this post last week made the point that fixed income annuity, or "FIA," riders are a dream-come-true for a retirement income planner like me since it enables me to offer a unique solution for meeting clients' income needs that isn't available elsewhere from other investment products. It emphasized that the five things you receive from a FIA income rider, when taken as a whole, cannot be duplicated by any other investment.

The first two features, guaranteed income and flexible lifetime retirement paycheck, or "LRP," start date were the subject of last week's post. This week we'll take a look at the other three features.

5 Things You Receive From a Fixed Index Annuity Income Rider – Part 1 of 2

As the saying goes, it's better to give than to receive. With this in mind, the last three week's posts focused on what you don't receive when you purchase an income rider with a fixed index annuity, or "FIA." With Christmas and Hanukkah just behind us as I write this week's post, it's time to take a look at what you receive from this optional addition to your FIA.

Let's start with some basic terminology. Although many life insurance companies refer to it as an income rider, you will also see the phrase, guaranteed minimum withdrawal benefit rider, or "GMWB" rider, for short. The latter terminology is simply another name for an income rider.

Annuitization Tax Treatment of Nonretirement Distributions

Per last week's post, there are four things that you don't receive when you purchase an income rider with a fixed index annuity that are associated with fixed income annuities. The first three, i.e., annuitization, immediate payments, and ability to receive payments over a fixed period, were discussed in last week's post. The fourth thing – annuitization tax treatment of nonretirement distributions – is the subject of this week's post.

Before we discuss tax treatment of distributions, I want to talk briefly about taxation of annuities during the accumulation stage before any distributions are made. Similar to IRA's and other qualified retirement plans, unless they're immediately annuitized, all annuities, including fixed income annuities, enjoy tax-deferred growth. That is, until distributions are taken, there's no taxation. This is true whether the annuity is held within a nonretirement account, a traditional IRA or other qualified plan, or a Roth IRA.

Your Fixed Index Annuity Income Rider – What You Don’t Receive – Part 2 of 2

Per Part 1 of this two-part series, before we talk about what you receive when you purchase an income rider with a fixed index annuity, it's important to understand what you don't receive. As stated last week, this needs to be placed in the context of fixed income annuities. If you haven't done so already, I recommend that you read last week's post before continuing with this one.

There are four things that you don't receive when you purchase an income rider with a fixed index annuity that are associated with fixed income annuities:   

1. Annuitization
2. Immediate payments
3. Ability to receive payments over a fixed period
4. Annuitization tax treatment of nonretirement distributions

Your Fixed Index Annuity Income Rider – What You Don’t Receive – Part 1 of 2

As stated in last week's post, while a fixed index annuity has several unique conservative and desirable investment features, assuming your goal is to create a lifetime retirement paycheck, you need to apply for an optional income rider when your retirement income planner submits your application. As pointed out last week, income riders are currently available with less than 40% of all fixed index annuities.

What exactly do you receive when you purchase an income rider with your fixed index annuity? How does it work? How can it be used as part of a retirement income planning strategy to create a lifetime retirement paycheck?

Add an Income Rider to Your Fixed Index Annuity to Create a Retirement Paycheck

As stressed in the last three week's posts, Where Have All the Pensions Gone?, A Retirement Paycheck is Essential, and No Pension? Create Your Own, we need to know that when we stop working, we will receive a predetermined monthly payment, i.e., a retirement paycheck, for the rest of our life, and, if married, our spouse's life. Furthermore, due to its inadequacy and uncertainty, this monthly payment needs to be in addition to whatever Social Security benefits we may receive.

Per last week's post, No Pension? Create Your Own, a retirement income planning strategy that's becoming more widely used the last few years is the addition of a rider, or endorsement, to a fixed index annuity to generate a retirement paycheck. The concept of fixed index annuities isn't new to readers of Retirement Income Visions™. This topic has been featured for the last five months, beginning with the July 11, 2011 post, Shelter a Portion of Your Portfolio From the Next Stock Market Freefall.

No Pension? Create Your Own

Last week's post, A Retirement Paycheck is Essential, emphasized that it's imperative for each and every one of us to have a retirement income plan. The cornerstone of a retirement income plan is a retirement paycheck. Specifically, we need to know that when we stop working, we will receive a predetermined monthly payment for the rest of our life, and, if married, our spouse's life. Furthermore, this monthly payment needs to be in addition to whatever Social Security benefits we may receive.

Given the fact that the majority of us won't receive a pension from an employer's defined benefit plan that our parents' generation took for granted (see the November 21, 2011 post, Where Have All the Pensions Gone?), it's incumbent upon us to create our own retirement paycheck. This isn't an task and generally requires the assistance of an experienced retirement income planner.

How to Get Interest Credited to Your Fixed Index Annuity When the Market Declines

Last week's post, Don't Neglect Your Fixed Index Annuity Fixed Account, made the point that you're not guaranteed to receive interest crediting with the majority of fixed index annuity indexing methods due to the fact that interest is only credited when the result of the calculation is positive. Per the post, one way to obtain interest crediting in the event of negative performance of your chosen index or indeces, is to allocate a portion, or perhaps all, of your fixed index annuity to the fixed account.

Per last week's post, to the extent that you choose the fixed account, you will receive three benefits unavailable from traditional indexing methods: (1) guaranteed return, (2) pre-determined return, and (3) opportunity to offset a portion or all of an income rider charge in the event of a negative indexing method return. While the predetermined annual return is generally very favorable to that of a one-year CD, it is nonetheless modest, typically in the range of 1% to 2% these days.

Don’t Neglect Your Fixed Index Annuity Fixed Account

Last week's post, Diversify Your Fixed Index Annuity Indexing Methods discussed four basic strategies that you can use to diversify your fixed index annuity indexing methods to reduce the pressure of picking the "winning horse" and improve your chances for obtaining interest crediting in a particular year. One of the strategies, allocation of accumulation value to the fixed account, is the topic of this week's post.

Per last week's post, unlike indexing methods that are generally tied to the performance of a stock market index, the fixed account credits a predetermined fixed interest rate for the percentage of your fixed index annuity that is allocated to this investment choice. The fixed account offers three advantages over traditional index crediting methods 

1. Guaranteed return
2. Pre-determined return
3. Opportunity to offset a portion or all of an income rider charge in the event of a negative indexing method return

Diversify Your Fixed Index Annuity Indexing Methods

Per the conclusion of last week's post, Which is the Best Fixed Index Annuity Indexing Method?, no one can predict how a particular fixed index annuity indexing method will perform during any contract year. Differences in contract dates, stock market indexes, and cap rates, combined with the unpredictability of the stock market itself, makes it extremely difficult, if not impossible, to forecast the best performing method for any contract year.

Given this reality, there are four basic strategies that you can use to diversify your fixed index annuity indexing methods to reduce the pressure of picking the "winning horse" and improve your chances for obtaining interest crediting in a particular contract year:

1. Select multiple methods
2. Choose a blended index if available
3. Purchase multiple fixed index annuity contracts
4. Use the fixed account

Which is the Best Fixed Index Annuity Indexing Method?

Beginning with the August 22, 2011 post, How Does Your Fixed Index Annuity Grow?, fixed index annuity strategies, and, in particular, indexing methods, have been the focus of the last nine posts. The last four posts explained four methods, with the first three being the most widely used:

1. 1. Annual point-to-point cap method
2. 2. Monthly point-to-point cap method, or monthly sum crediting method
3. 3. Monthly average method
4. 4. Trigger Indexing method

Each of these methods is used to determine the amount of interest that's credited to a fixed index annuity each year. So which of these four methods is the best one? Is there one method that consistently produces superior results and should be favored over the others?

Fixed Index Annuity Indexing Method with a Trigger

The last three posts introduced three fixed index annuity indexing methods that are used to determine the annual amount of interest that is credited to a fixed index annuity:

1. Annual point-to-point cap method
2. Monthly point-to-point cap method, or monthly sum crediting method
3. Monthly average method

With each of these three methods, the amount of interest that's credited during a particular contract year is unknown ahead of time, must be calculated, and generally changes year to year. Like all indexing methods, if the result of the calculation is negative, no interest is credited.

There's a fourth indexing method that's not as widely used as the other three methods known as trigger indexing. The basic difference between trigger indexing and the other three indexing methods is that the interest rate isn't calculated using trigger indexing. It's instead a predefined percentage that's triggered by a specified event. The predefined percentage is credited in each contract year during which the value of the specified stock market index at the end of the year is greater than or equal to its value at the beginning of the year. The amount of the change in the index during the year is irrelevant.

Monthly Average vs. Monthly Point-to-Point Fixed Index Annuity Indexing Method

We continue our miniseries about fixed index annuity indexing methods that began on September12th with a discussion of the monthly average indexing method. The previous two posts, What's the Point-to-Point? and Monthly vs. Annual Point-to-point Fixed Index Annuity Indexing Method introduced the annual and monthly point-to-point methods, respectively.

In order to help you understand the monthly average indexing method, we will compare it to the monthly point-to-point, or monthly sum crediting method as it is otherwise known. Per last week's post, there are three steps associated with the latter method that are performed each contract year:

1. Calculate twelve monthly percentage changes in selected stock market index.
2. Apply the product's cap rate to each of the twelve monthly percentage changes.
3. Add the twelve monthly capped percentage changes together to determine the annual interest amount to be credited.

Monthly vs. Annual Point-to-Point Fixed Index Annuity Indexing Method

Last week's post, What's the Point-to-Point?, introduced the annual point-to-point cap method, which is the simplest fixed index annuity indexing method. This post will discuss the monthly point-to-point cap method and  will compare it to the annual point-to-point cap method.

The monthly point-to-point cap method, or monthly sum crediting method as it's otherwise known, is similar to the annual point-to-point cap method, with the following three differences:

1. The calculation involves the determination of twelve monthly percentage changes vs. one annual percentage change.
2. The limit, or cap rate, is applied to each monthly percentage change, or 12 times, vs. one time with the annual point-to-point cap method.
3. The monthly capped changes are added together to determine the annual interest amount to be credited.

What’s the Point-to-Point?

Per last week's post, Fixed Index Annuity Indexing Method Similarities, most indexing methods share three features: (1) Reliance on a stock market index, (2) Measurement of percentage changes between two points in time, and (3) Use of cap rates.

All three of these features are common to the annual and monthly point-to-point cap methods. The latter method is also often referred to as the monthly sum crediting method. These two methods are the most common indexing methods that are used to calculate annual interest crediting on fixed index annuities.

Fixed Index Annuity Indexing Method Similarities

As emphasized in the September 12, 2011 post, Introduction to Fixed Index Annuity Indexing Methods, it's important to keep in mind one of the basic tenets of fixed index annuity interest crediting that applies to all fixed index annuities, i.e., you only participate in gains, not losses. No matter which indexing strategy(ies) you select, if the annual calculation of the gain or loss results in a loss, you won't realize, or be credited, with any loss. 

So how is interest crediting calculated? Fixed index annuity indexing methods have several things in common. With some exceptions, which will be the topic of a future post, most methods share the following three features:

1. Reliance on a stock market index
2. Measurement of percentage changes between two points in time
3. Use of cap rates

Introduction to Fixed Index Annuity Indexing Methods

As stated at the conclusion of last week's post, fixed index annuity interest crediting is determined on an annual basis by the performance of one or more chosen stock market indexes and indexing methods based on the original contract date. As a result, there are generally 365 possible measuring periods.

Since stock prices often change daily, there is a high likelihood that the price of a particular stock index, which can be based on stock prices of dozens, hundreds, or even thousands, of individual companies, will fluctuate on a daily basis. Consequently, individual fixed index annuity interest crediting can vary widely from contract to contract even if identical stock market indexes and indexing methods are chosen. Since performance is date sensitive, different indexing strategies may be superior to others within the same year, let alone from year to year.

Contract Date – The Driver of Fixed Index Annuity Performance

Last week's post began a discussion about the second way that fixed index annuities grow in addition to a contract's defined minimum guarantees – indexing strategies. It pointed out that there are actually two choices that you need to make when selecting a particular indexing strategy: (1) Stock market index and (2) Indexing method. Stock market indexes, including how they work and the different types that are typically available when working with fixed indexed annuities, was the subject of last week's post.

What is the purpose of an indexing method? An indexing method, together with a particular stock market index, determines the amount of interest that is credited to the value of a fixed index annuity on the contract anniversary date each year. Interest crediting is flexible and will vary for each fixed index annuity contract based on several factors.

Indexing Strategies – The Key to Fixed Index Annuity Growth

Last week's post introduced the two ways that fixed index annuities grow: (1) minimum guarantees and (2) indexing strategies. The minimum guarantee feature, which was discussed last week, is the security blanket that provides the foundation for growth of a fixed index annuity. Per the conclusion of last week's post, this is the minimum accumulation value that would be paid by the life insurance company to the investor if the investor terminates his/her contract, or to the beneficiary in the event of death.

As discussed in the July 18, 2011 post, Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities, indexed annuities are a hybrid product, with returns directly tied to the performance of a stated stock market index. When you complete a fixed index annuity application, you need to choose, and allocate between, one or more indexing strategies.

How Does Your Fixed Index Annuity Grow?

"Mary, Mary, quite contrary, how does your garden grow? With silver bells, and cockle shells, and pretty maids all in a row." Applied to fixed index annuities, this popular English nursery rhyme might read as follows: "FIA, FIA, quite contrary, how does your accumulation value grow? With minimum guarantees, and indexing strategies, and not too many down years in a row." Please note that all references to "guarantees" are subject to the claims-paying ability of individual life insurance companies issuing fixed index annuity contracts.

With each passing week, Retirement Income Visions™ ongoing fixed index annuities series that began on July 11^th with Shelter a Portion of Your Portfolio From the Next Stock Market Freefall is proving to be very timely. Volatility has been the name of the game since the Dow Jones Industrial Average closed at its recent high of 12,724.41 on July 21^st. With its close of 10,817.65 on Friday, the Dow is down 1,906.76, or 15%, in 21 trading sessions since July 21^st. This has included six trading sessions with changes of 420 – 635 points from the previous session close, with four of those being declines.

When is the Best Time to Invest in Indexed Annuities?

This past week's stock market slide, culminated by Standard & Poor's unprecedented U.S. credit rating downgrade from AAA to AA+ on Friday, has raised investors' anxiety level. Closing the week at 11,444.61, the 698.63 point weekly decline in the Dow Jones Industrial Average on the heels of a loss of 581.17 points, or total loss of 1,279.80 points, or 10.1%, from its close of 12,724.41 on July 21^st just fifteen days ago, has prompted nervous investors to seek shelter.

An indexed annuity investor would have been unscathed by the past two weeks' stock market thrashing. As stated in three consecutive posts beginning with the July 11^th Shelter a Portion of Your Portfolio From the Next Stock Market Freefall, indexed annuities offer upside potential with downside protection. Specifically, if the return of the index to which the indexed annuity is tied is negative, no loss is posted to your account. You will instead be credited with your indexed annuity contract's minimum rate of return.

Do You Want to Limit Your Potential Gains?

With Tuesday's debt-limit deadline just three days away as I write this post following six straight sessions of declines in the Dow Jones Industrial Average, with a total loss of 581.17 points, or 4.6%, from its close of 12,724.41 on July 21^st to 12,143.24 on Friday, the American public is understandably on edge. An investment in U.S. government bonds, a traditional safe haven, is no longer the gold standard in the face of a potential unprecedented imminent rating downgrade.

So the proverbial question, "Where do I invest my money?," is often heard during these uncertain times. Last week's post, Limit Your Losses to Zero, continued the discussion of indexed annuities, a defensive investment strategy that protects against, and eliminates, market losses. Unlike the value of a direct investment in a market index which fluctuates up and down in response to the performance of the particular index, an investor's return in an indexed annuity is controlled. Losses are never realized, with minimum rates of return credited during market declines. Per the example in last week's post, whereas an investment of $100,000 in the Dow Jones Industrial Average on October 9, 2007 declined in value to approximately $78,000 three years later, the same investment in an indexed annuity grew to approximately $113,000, or $35,000, or 45% more.

Limit Your Losses to Zero

When the Dow Jones Industrial Average declined by 7,617.48 points, or 53.8%, going from an all-time high of 14,164.53 on October 9, 2007 to a low of 6,547.05 on March 9, 2009 in just seventeen months, what did you do and how did you feel? Assuming you were in the stock market, did you remain fully invested or did you liquidate a portion, or maybe even all, of your holdings?

Looking for Upside Potential With Downside Protection – Take a Look at Indexed Annuities

Last week's blog post introduced a type of investment that may not be familiar to many of you – indexed annuities. For those of you who missed it, an indexed annuity is basically a fixed annuity that offers a guaranteed interest rate for a set period of time. Two features of fixed annuities that have traditionally made them a preferred investment choice when compared to similar-duration CD's are higher interest rates and tax-deferred growth.

Indexed annuities take it one step further. In addition to having the two aforementioned features, indexed annuities offer upside potential, i.e., a higher potential rate of return than traditional fixed annuities. While the higher rate of return isn't guaranteed, there's always a fixed rate of return that provides downside protection.

Shelter a Portion of Your Portfolio From the Next Stock Market Freefall

Although there have been a few bumps in the road and it's highly unlikely that it will continue at the same pace, those of us who have been invested in the stock market for the last two years have enjoyed a very nice ride. With the Dow Jones Industrial Average closing at 12,657.20 on Friday, the index has increased by 4,478.79 points, or 54.8%, from its close of 8,178.41 on July 8, 2009.

As quickly as the market can increase in value, the opposite can also happen. Ironically, although over a shorter period of time, the Dow Jones Industrial Average experienced almost the identical percentage loss when it went from its all-time high of 14,164.53 on October 9, 2007 until it bottomed out at 6,547.05 on March 9, 2009. The loss of 7,617.48 points, or 53.8%, occurred in just seventeen months, or seven months less than the recent increase of 54.8% over the last two years.