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  • Michael Pizzitola, CFP

Index Annuity Pros and Cons

In times when the market is volatile, you may be looking for something that gives you assurance that you cannot lose your money. In times of low interest, you may want your safe money to be able to have market upside potential. This is what the Index Annuity promises.

The Pros are the promise that Index annuities combine the safety of a fixed annuity with some upside of a stock market investment. As with any deferred annuity, it allows you defer taxes until you pull the money out.

The Cons are in the details. These are very complex products with several components that need to be considered. The primary components are as follows:

Participation Rates: How much of an index’s gain is credited to the annuity.

Spread/Margin/Asset fee: These fees are subtracted from the gain. These may be used instead of a Participation Rate.

Interest Rate Caps: This puts a top end on how much the investment can earn in each period. This is more relevant in very strong years in the market (i.e. 20% market return with a 6% cap = 6% for the investor and much of the rest for the insurance company).

Indexing Method: This is how the increase periods are determined. The most common are the Rachet method (annual reset), High Water Mark, and Point-to-Point. There are more options but the primary thing to consider is this -- with each of these methods, typically the longer the time frame for each lock, the more potential for keeping upside.

Also important to note is that dividends may or may not be calculated in the equation.

Whether you can lose money or not depends primarily on three things:

1. Is the insurance company able to pay? This is an extremely low risk issue. If you choose a well rated company, the probability they would not be able to pay is low. See to find companies that will evaluate an insurance company’s financial strength.

2. Does the contract have a guarantee of something LESS than 100%? This would allow the insurance company to pay whatever that floor is (i.e. 85%).

3. Do you need to take the money out early? If you surrender your annuity prior to maturity, some insurance companies may have you surrender index linked interest.

As with any deferred annuity, the gains will be subject to tax as income and any money drawn without annuitizing the asset will be taxed gains first.

Other questions to ask: Is the benefit tied to annuitizing at some point? If so, what is the rate that they will annuitize the money?

At NS Capital, when we are looking at investments, one of the questions we ask is “Are you receiving value for what you are paying?”. Given that the cost of Index Annuities are (at best) opaque and (at worst) egregious, we believe the best strategy is separating your components of safety and certainty along with gains seeking in a ratio that fits your goals and risk tolerance. If you would like to explore Index Annuities further, please reference the following:

FINRA: Equity-Indexed Annuities: A Complex Choice

Consumer Reports: Why Indexed Annuities May Promise More Than They Deliver

About the Author:

Michael Pizzitola, CFP® is a Managing Director at NS Capital with over 25 years in the financial industry. He provides asset management and portfolio construction services for individuals and small businesses that are looking for a different approach to having their assets managed. Throughout his career, Michael has had the privilege of advising hundreds of clients throughout the greater Baltimore, Washington DC and Philadelphia area achieve their long-term financial goals. Feel free to write to Michael at with any questions or comments.

Disclaimer: The preceding article is for discussion purposes only and does not represent the full details on the subject matter. The author and NS Capital LLS are not responsible for regulation changes which may deem this information outdated or incorrect. Readers are encouraged to contact their Financial Advisor for more information.

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