Can Annuities Outperform Stocks

Annuities are generally considered to be safer than stocks as retirement investments, but their safety comes at a price - relatively low investment returns. Conventional wisdom has it that annuities cannot outperform stocks in a growth market, but is this true. The new equity-indexed annuities may offer the best of both worlds: safety for the principal with the potential for high interest gains.

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According to industry analysts, the average index annuity provided a credited interest rate of 5.57 percent over a five-year period. For a Standard & Poor's 500 Stock Index fund that had a 0.15 percent expense ratio over the same period, the annualized return totaled 5.05 percent. And while the index annuity returns did not include any reinvested dividends, the reset method used provided protection from losses of principal, and the interest credited offered a higher return.

The real story is that when the S&P 500 dropped by 27 percent in October 2003, the equity-indexed annuity held its value. If an investor had put $100,000 in the average index annuity on September 30, 2003, they obtained a total of $131, 130 on September 30, 2008 and continued to hold that amount at the end of October. If the same $100,000 had been put into an index fund, it would have been valued at $127,932 at the end of September and only $93,237 by the end of October 2003.

This example indicates that equity-indexed annuities do have the potential to outperform traditional annuities and are useful in avoiding the downside risks of traditional stock market approaches. This happy situation is the result of the face that the interest credited to an indexed annuity is based on commonly used indexes like the S&P 500 with a guarantee that this interest rate will never drop below zero. So there is the potential for higher returns at significantly lowered risk.

Equity-indexed annuities are not designed to outperform the market, however. They were created as hybrid investment vehicles to combine the growth potential of the market with the safety of a fixed annuity. Potential growth is usually limited to seven percent to 12 percent, but there are no worries about losing life savings.

Some brokers believe that indexed annuities are not a good choice for senior citizens because of the limits on total earnings, but retirees favor equity-indexed annuity plans for the safety they provide to investment principal. The sales of equity-indexed annuities totaled $23.3 billion in 2004, according to the National Association of Insurance Commissioners, and only 38 closed complaints were filed about these plans. This translates to $614 million in sales for every filed complaint.

The greatest problem associated with equity-indexed annuities is the way they may be presented. Some brokers and agents present these plans as if they are all things to all investors. While the plans have excellent features, their limitations must be considered as well. It is important to remember that some insurance companies will offer unlimited growth potential in the first year of a contract, but are not forthcoming about how they will mitigate these gains in later contract years.

Investors should learn all they can about equity-indexed annuities before purchasing them. They must determine whether these plans really meet their needs, since scenarios may occur where money may be lost. Consulting a professional investment advisor is highly recommended before making a decision about these complex financial products.

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