Shortly after the stock market began its initial descent, Rob Phelan, a high school math teacher in Maryland, received an email sales pitch: “The Coronavirus may be Fatal — to Your Retirement Savings!”
The note, punctuated with exclamation points, offered a seemingly magical solution, something called a fixed-index annuity. Its “value can only go up!” the note said.
If that sounds too good to be true, that’s because it probably is.
Shellshocked investors will need to scrutinize sales pitches like this and not jump to make purchases in the middle of a major downturn, when they may be most vulnerable.
Not all annuities are ill-advised. Some products can provide retirees with a pension-like stream of income, a valuable benefit that can bring peace of mind and a basic level of financial security. But fixed-index annuities are often pushed as a panacea to plunging markets, a safer alternative that allows investors to capture at least some of the gains, with none of the downside.
The note, which Mr. Phelan received earlier this month, said: “When the stock market goes up, its value goes up with the market. But if the stock market drops, it holds its value.”
In reality, that claim about fixed-index annuities is only partly accurate. They are essentially a form of insurance that tends to generate returns similar to certificates of deposit. But they have several attributes that are less appealing. Most of your money is often locked up for many years, accessible only if you pay a painfully high surrender fee. And annuity brokers often collect commissions of 5 to 8 percent of the money invested, sometimes more, so they have a big incentive to close the sale.
“They are not designed or intended to be stock market competitors, even though everywhere you look they are sold that way,” said Scott Dauenhauer, a financial planner and founder of Meridian Wealth Management in Murrieta, Calif. “A lot of them are being sold by people who are only licensed to sell fixed products. And if that is all you can sell, that is probably all you are likely to sell.”
And even before the novel coronavirus, they were selling briskly. Fixed-index annuity sales rose to $74 billion in 2019, a 6 percent increase from the previous year, according to Cerulli Associates, a research and consulting firm in Boston.
People often don’t understand the complex inner workings of these investments. “If you need more than the back of a cocktail napkin to explain the math, I’d be concerned,” said Mark Cortazzo, a financial planner and founder of Annuity Review, a service that analyzes annuity policies for a flat fee.
On the surface, fixed-index annuities are attractive. You won’t lose your initial investment, and you will receive a guaranteed minimum rate of interest and have a chance of collecting slightly more if the stock market does well. But that’s where things get murky.
The investment is typically tied to an index — often the S&P 500, but, sometimes, a proprietary index you’ve probably never heard of. Your annual return is often capped at, say, 2.5 to 4 percent. That cap can change from year to year, and the insurance company may use other levers to limit your upside. And the performance of the investment may trail the underlying index, because it often doesn’t include dividends.
Then, there are the less than obvious costs. The email pitch sent to Mr. Phelan proclaimed that fixed-index annuities “often cost nothing at all!” That’s not true either, annuity experts said. The costs are baked into the overall returns. There are a rising number of fixed-index annuities available through registered investment advisers, which some experts said offer a better value. But if the adviser is charging 1 percent or more for their services, “it might erase any benefit,” Mr. Dauenhauer added.
Digesting all of the details is challenging. “One of the things you don’t want to do is buy them when you are emotional,” said David Lau, founder and chief executive officer of DPL Financial Partners, which helps financial advisers find insurance products for their clients. “Now is not the time to rush out and buy an annuity because you are feeling panicked.”
Other fairly complex annuities are being offered, too. One is called a buffer annuity, which allows investors to capture some gains, while curbing some, but not all, losses. Then there are variable annuities, which may promise guaranteed income. They are essentially a portfolio of investments tied to an insurance policy, which can be expensive, yet they are frequently being offered to teachers and other public school employees.
Mr. Lau suggested focusing not on what is being pitched, but on the problem you’re wanting to solve. Maybe that’s a guaranteed stream of income, or ensuring you have enough to cover your fixed expenses.
Stan Haithcock, an agent who calls himself “Stan The Annuity Man,” said he’s been selling plain vanilla annuities that offer guaranteed income, but even these come in different varieties. One is a single-premium immediate annuity, which pays a guaranteed lifetime stream of income in exchange for a lump sum of cash. The other is a deferred income annuity, which starts the income stream at a future date, not immediately.
“People are starting to realize they need more lifetime income,” said Mr. Haithcock of Ponte Vedra Beach, Fla. “The problem is, agents aren’t selling the simplistic pro-customer annuities, they are trying to fit a square peg into a round hole.”
As for Mr. Phelan, who teaches personal finance as well as math, he didn’t buy the investment he was offered. He said the timing made it seem a bit predatory, and he was happy to stick with his low-cost index funds.
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