Wednesday, May 25, 2005
Living Benefit and Variable Annuities
Okay, so I was talking about the living benefit. I told you my position is that it can be very confusing. Incidentally, I got a call from an agent yesterday who was truly genuine and concerned to always do the right thing for his clients.
We got into a conversation about the living benefit. He told me of an annuity that would offer 12.5% return over a 20 year guarantee period. Now, this sounds wonderful, right? And a little too good to be true, right? On the surface, it looks like the client gets 12.5% per year if the market does not do well over a 20 year period. But here is how it really works. The guarantee is 12.5% of the amount you invest each year for 20 years. So if you put in $100K, you would be guaranteed $12,500 the first year and increases $12,500 per year until year 20 where your principal would be worth $250,000 in this case.
So the bottom line is that if the market didn't perform you would be guaranteed 250% of your original principal at the end of 20 years. Now pay attention. Here is how to see if the living benefit is worth paying for. First of all, the rate of return annualized for this type of return is around 4.68%. So let's initially compare that with any other 20 year rate of return...Hmmm....I think I could get 4.68% anywhere for 20 years on my money (probably for less time that that too). Furthermore, the chances of the market returning less than 4.68% over 20 years is slim to none. In the worst 20 year period, the S&P returned an annual average of 6.43% (according to http://www.mutualofamerica.com/articles/CapMan/October03/SandP500.htm.)
So logically, if you pay extra for this feature, it proboably doesn't make sense. Now seriously, there's always exceptions to the rule because anything can happen in the stock market. But if this feature cost you .50% and the annuity cost you 2.50% you now have 3% in expenses. And chances are you will never need nor use it so you have mitigated your returns and paid an extra $500 or more per year for 20 years in this case (hey $10,000 is a lot of money).
Living benefits are tricky and weighted heavily to favor the insurance company...not the client. Before you pay for a living benefit, analyze it in this way to see if it makes sense. Again, I am not against them completely, I just think you better understand them.
Ignorance is Not Bliss!!!
By the way, some of you have asked me for resources regarding the stock market. Here are two such resources:
Stock Market Basics
and
Stock Market Directory
Out!!!
We got into a conversation about the living benefit. He told me of an annuity that would offer 12.5% return over a 20 year guarantee period. Now, this sounds wonderful, right? And a little too good to be true, right? On the surface, it looks like the client gets 12.5% per year if the market does not do well over a 20 year period. But here is how it really works. The guarantee is 12.5% of the amount you invest each year for 20 years. So if you put in $100K, you would be guaranteed $12,500 the first year and increases $12,500 per year until year 20 where your principal would be worth $250,000 in this case.
So the bottom line is that if the market didn't perform you would be guaranteed 250% of your original principal at the end of 20 years. Now pay attention. Here is how to see if the living benefit is worth paying for. First of all, the rate of return annualized for this type of return is around 4.68%. So let's initially compare that with any other 20 year rate of return...Hmmm....I think I could get 4.68% anywhere for 20 years on my money (probably for less time that that too). Furthermore, the chances of the market returning less than 4.68% over 20 years is slim to none. In the worst 20 year period, the S&P returned an annual average of 6.43% (according to http://www.mutualofamerica.com/articles/CapMan/October03/SandP500.htm.)
So logically, if you pay extra for this feature, it proboably doesn't make sense. Now seriously, there's always exceptions to the rule because anything can happen in the stock market. But if this feature cost you .50% and the annuity cost you 2.50% you now have 3% in expenses. And chances are you will never need nor use it so you have mitigated your returns and paid an extra $500 or more per year for 20 years in this case (hey $10,000 is a lot of money).
Living benefits are tricky and weighted heavily to favor the insurance company...not the client. Before you pay for a living benefit, analyze it in this way to see if it makes sense. Again, I am not against them completely, I just think you better understand them.
Ignorance is Not Bliss!!!
By the way, some of you have asked me for resources regarding the stock market. Here are two such resources:
Stock Market Basics
and
Stock Market Directory
Out!!!
