Filed Under:Annuities, Variable

Are some index annuities two-tiered annuities in disguise?

Photo credit: lkunl
Photo credit: lkunl

Although two-tiered annuities provided significant value to those clients who desired safety and were willing to receive their funds over time, they also generated quite a bit of heartburn for insurance companies and agents when clients who misunderstood the design tried to access their funds. 

Two-tiered annuities were big sellers in the late 80s and early 90s. The basic concept was that if a client agreed to hold (defer) his or her contract for a minimum of 1 to 5 years and, when he or she was ready to access their funds, was willing to take them as a series of payments (annuitize) for a minimum of 5 to 10 years, the company could afford to pay a bonus of 10 percent or more. The bonus was the “sizzle” that sold the steak. 

Now, let’s complicate the process. Interest rates drop, the market (S&P 500) is volatile. The “steak” is harder to sell. Now everybody is talking about income riders. We had a variable annuity wholesaler visit our office last week and not once did he mention the contract itself or the sub-accounts offered. The entire discussion was about their new, improved income rider.

Just like two-tiered annuities, the insurance company keeps two sets of books. The first is the policy itself. Whether variable, fixed or indexed, the underlying policy must make sense for the client. This is the “cash” account and fully available based on the terms of the policy (free withdrawal, surrender charge, etc.)

Fees charged against income base rather than accumulation value — This is one of the areas where companies will “squeeze the balloon.” Let’s assume the index performs poorly or stays flat. If the company charges a 0.80 percent fee against the increasing income base, every year, a larger and larger deduction is made against the cash account, creating a downward spiral on a supposedly guaranteed asset. 

Non RMD or free withdrawal friendly — Harry retires from his job at age 55 and rolls over his $500,000 401(k) to your indexed annuity. He plans on consulting for the next 10 years until he is 65, then taking income. At 52, he has an emergency and, understanding the tax consequences, takes a 10 percent free withdrawal. He turns on the income switch at age 65 only to find that his payout percentage was locked in at age 52 due to the withdrawal. Is your E&O paid up? 

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Nichole Morford

Nichole Morford
Managing Editor

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