The Cash Flow Clock: For Retirees - Book - Page 49
The Cash Flow Clock
(10% per year) than banks. They are also known as MYGAs (Multi Year
Guaranteed Annuities).
Fixed Index Annuities (FIA) are like index CDs. They are guaranteed not
to lose but are not guaranteed to grow. Their growth depends on what index
is being used. If the index grows, the annuity grows. If the index loses, the
annuity does not lose. The insurance company does not credit all of the
upside while protecting from the downside. Growth is limited with either a
cap or a participation rate (or both). If the market is down, we don’t lose.
Prior year growth becomes part of the guaranteed principal at the end of
each year and is protected from future losses.
Recently, insurance companies realized that not everyone needs income for a
lifetime. Some are simply looking for growth with downside protection.
MYGAs and FIAs are great alternatives to CD and Index CDs. They also
make attractive alternatives to bond funds, especially in a rising interest rate
environment.
Annuities have a contract term which can range from a couple of years to 10
years or longer. During this contract period, withdrawing our funds may
result in a surrender charge. This surrender charge can vary from one
company to another but is usually close to the number or years left in the
contract. For example, if there are 8 years left in the contract, the surrender
charge is likely around 8%. As the contract gets closer to expiring, the
surrender charge gets closer to zero.
Annuity liquidity can also be limited by a Market Value Adjustment (MVA).
An MVA can increase or decrease the surrender value of an annuity
depending on how interest rates have changed since the annuity was
purchased. When interest rates are high, insurance companies can purchase
bonds at higher rates and can pass on that higher growth to their clients. An
MVA can make it more difficult for an annuity holder to move from a
product that was purchased when interest rates were lower to a new one in a
high interest rate environment. The MVA is not applicable after the contract
term has expired.
For most annuities, at least 10% of the contract value is liquid each year. If
we are considering annuities as potential investments in our portfolio, it is
critical that we understand how the surrender charges and MVA might affect
our liquidity. If the 10% per year is sufficient liquidity, an annuity might be
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