Bob Clark, a columnist for Investment Advisor magazine, recently said, "...the role of advisors is to protect their clients from the financial services industry". Many times the products pushed by the large financial service firms do more harm to investors than good. The "hot" product du jour is currently the Equity Index Annuity.
While the equity index Annuity itself is not an evil thing, the way they are presented to investors is many times misleading, and they are often pushed to be a much larger part of a portfolio than prudence would justify.
In brief, an equity index annuity, provides returns that a related to some stock market index. As such they can be viewed as an equity derivative (remember those?). Investors typically receive a return that is some portion of the return of an index like the S&P 500 (for example 90% of the point to point return of the price increase of the index, not including dividends), the average monthly return of the index over a predetermined period (again not including dividends), or the monthly gain of the index with a predetermined cap (often 2-3% per month cap). The big draw is that you receive a guarantee that your account will not have a negative return over some period of time. Often touted as "heads you win, tails you don't loose". On the face that sounds enticing. It is only if you kick the tires that problems become apparent.
First, like most annuities there is a long period of time where you a charged a surrender charge if you want or need to withdraw more funds than allowed in the contract (I have even seen instances where the surrender charge is applied to any withdrawal except in the case of annuitization).
Second, any gain from annuities is considered to be distributed first, and taxed as ordinary income (you do not get favorable dividend of capital gain rate when you file your taxes), and any distribution before age 59 1/2 could be subject to a 10% premature distribution tax penalty.
Worst of all the returns investors receive will likely not measure up to expectations. The pitfalls of monthly caps and averaging returns requires some contemplation to understand. Let's say you are credited with any market gains up to 2% each month. That means if the index you participate in goes up by 2% you are credited with the full 2%, if the index goes up 3%, sorry, you are still only credited with 2%. Okay, you say, that's not so bad, I can still earn a whopping 24% in a year! In theory yes, in practice, no. See sometimes, even in a very good year, markets will fall back some months. And you equity indexed annuity lets you participate fully in the monthly market drops, as long as the account moves no further than 0% in a year. If the index you participate in rises by 3% one month, the 1% the next month, but falls by 3% the following month, your account earns zero, nada, zilch. You were credited with 2% the first month, then 1% the second month, but got dinged for the full minus 3% in the third month.
It's all very confusing, and people hear what they want to hear. That is what the insurance companies and agents who sell equity index annuities are counting on. Heads the insurance company wins, tails, you lose.
Individuals with special needs and families that seek to help, have long been hamstrung by the Catch 22 of public assistance. If a family provides too much financial assistance, the beneficiary loses access to government assistance. If the family does not help the individual may suffer from lack of access to housing and education. For special needs individuals to receive an inheritance they needed a special needs trust or the inheritance was quickly depleted until the special needs individual once again attained poverty level to qualify for public assistance.
In 2014 congress passed the ABLE act to allow special needs beneficiaries’ families to establish a savings vehicle funded with up to $14,000 per year (adjusted for inflation) to supplement public assistance. The account may be used to pay for needs such as housing, education, transportation, and other expenses that improve the quality of life for those with disabilities.
Similar to 529 college saving plans, ABLE accounts are established by the states, but you can participate in the plan of a state other than your home state if you choose. The account may not hold more than $100,000 of assets without running afoul of the Supplemental Security Income rules, but still this is an improvement over the expense and complexity of using a special needs trust. For many families this account will prove invaluable.
To qualify for an account, the individual must have significant disabilities and the age at onset of the disability must be prior to attaining age 26. At the death the state where the beneficiary resides may be able to claim any balance remaining in the account under the Medicare payback rules.
Currently ABLE plans have been established by Florida, Nebraska, Ohio, and Tennessee. If you are not a resident of one of these states non-residents are allowed to establish accounts in Nebraska, Ohio, and Tennessee. For more information, you can visit the ABLE National Resource Center online.