Image Description

Are the Pieces of Your Retirement Plan Inflation Proof?

According to a recent article, consumer prices climbed further into the stratosphere in March, inflation hit a fresh 40-year high as continuing surges in gasoline, food and rent costs more than offset moderating prices for used cars.

The consumer price index leaped 8.5% annually in March, the fastest pace since December 1981, the Labor Department said, likely cementing Federal Reserve plans for an unusually large half-point interest rate hike soon. That increase is up from 7.9% in February, and inflation now has notched new 40-year highs for five straight months.

Are your retirement dollars protected from risk and potential losses? Is your CD or bank savings account making enough to keep pace with the rising inflation rates? With interest rates near historic lows (for example, 5-year CDs are paying under .3%), you may find it hard to rely on fixed income assets to achieve the growth you need to cover expenses in retirement.

Purchasing an annuity could help offset inflation and may reduce the future purchasing power of your money compared to low-accumulation products like CDs. Annuities also provide a safer accumulation product, like fixed indexed annuities, that could eliminate potential risks caused by inflation or other market downturns.

Two features having the greatest effect on the amount of additional interest that may be credited to a fixed index annuity are the indexing method selected and the participation rate. It is important to understand these features and how they work together. The following are some other fixed index annuity features that affect the index-linked opportunity.

  • Indexing method: The indexing method means the approach used to measure the amount of change, if any, in the index. Some of the most common indexing methods, which are explained more fully later on, include annual reset (ratcheting), high-water mark, and point-to-point.\
  • Term: The index term is the period over which index-linked interest is calculated. The interest is credited to the annuity at the end of a term. Terms are generally from one to 10 years, with six or seven years being most common. Some annuities offer single terms while others offer multiple, consecutive terms. There usually will be a window at the end of every term, typically 30 days, during which you may withdraw your money without penalty. For installment premium annuities, the payment of each premium may begin a new term for that premium.
  • Participation Rate: The participation rate decides how much of the increase in the index will be used to calculate the index-linked interest. For example, if the calculated change in the index is 10% and the participation rate is 70%, the index-linked interest rate for your annuity will be 7% (10% x 70% = 7%). A company may set a different participation rate for newly issued annuities as often as each day. Therefore, the initial participation rate in your annuity will depend on when it is issued by the company. The company usually guarantees the participation rate for a specific period (from one year to the entire term), and when that period is over, the company sets a new participation rate. Some annuities guarantee the participation rate will never be set lower than the specified minimum or higher than a specified maximum.
  • Cap Rate or Cap: Some annuities may put an upper limit or cap on the index-linked interest rate. This is the maximum rate of interest the annuity will earn. In the example given above, if the contract has a 6% cap rate, 6% and not 7% would be credited. Not all annuities have a cap rate.
  • The Floor on Fixed Index-Linked interest: The floor is the minimum index-linked interest rate you will earn. The most common floor is 0%. A 0% floor assures that even if the index decreases in value, the index-linked interest you earn will be zero and not negative. As in the case of a cap, not all annuities have a stated floor on index-linked interest rates. But in all cases, your fixed annuity will have a minimum guaranteed value.
  • Averaging: In some annuities, the average of an index’s value is used rather than the actual value of the index on a specific date. The index averaging may occur at the beginning, the end, or throughout the entire term of the annuity.
  • Interest Compounding: Some annuities pay simple interest during an index term. That means index-linked interest is added to your original premium but does not compound during the term. Others pay compound interest during a term, which means that index-linked interest that has already been credited also earns interest in the future. In either case, however, the interest earned in one term is usually compounded in the next.
  • Margin/Spread/Administrative Fee: In some annuities, the index-linked interest rate is computed by subtracting a specific percentage from any calculated change in the index. This percentage, sometimes referred to as the “margin,” “spread,” or “administrative fee,” might be instead of, or in addition to, a participation rate. For example, if the calculated change in the index is 10%, your annuity might specify that 2.25% will be subtracted from the rate to determine the interest rate credited. In this example, the company subtracts the percentage only if the change in the index produces a positive interest rate.
  • Vesting: Some annuities credit none of the index-linked interest or only part of it if you take out all your money before the end of the term. The percentage that is vested, or credited, generally increases as the term comes closer to its end and is always 100% at the end of the term.

Do you still have some questions about annuities? You can learn more in Annuity Alliance’s Resource Center, which has answers to commonly asked questions. You also can contact Annuity Alliance to get connected with a financial professional in your local area.