“What’s for Dinner?”

I’m sure you get them. I know I get a couple each month. I’ve even started to collect them. What am I talking about? I’m talking about the current hot marketing strategy in the financial services industry: invitations to presentations that include free dinner.

The invitations are usually headlined with some dramatic statement like, “Cut Taxes on Your IRA Withdrawals,” or “How to Protect Your Money in Troubled Times.” These statements and the bullet points that follow are designed to make you think that you are missing out on something. Therefore, you go to find out what it might be. Besides, there’s nothing wrong with a free dinner, right? Don’t be so sure....

One of the most common presentations focuses on a product called an Equity Indexed Annuity or EIA. EIAs are often touted as a way to participate in the stock market without the risk of losing money. Unfortunately, EIAs are a very complicated and often misunderstood and oversold product.

Despite the term ‘equity’ in the title, EIAs are just another form of fixed annuity. They are issued by insurance companies and retain all the tax-deferred features all annuities have. An EIA will pay you a minimum guaranteed rate of interest just like a fixed annuity. Then, you will earn an additional amount of interest based on the performance of the stock market. If the stock market goes up, you will participate in a portion of that rise; if the stock market goes down, you will still earn your guaranteed minimum. That’s the easy part, and the basis of the sales pitch. “Stock market-like returns, no risk”...sounds good! But, as usual, the devil is in the details.

First, let’s examine the guaranteed interest feature. A portion of your investment goes to pay administrative costs, sales commissions, and to buy stock market futures contracts. Therefore, only a portion of your investment can go into the corporate bonds that provide for the guaranteed interest resulting in a guaranteed interest rate that is below the current market rate of similar interest bearing instruments. Further, the interest is guaranteed only by the insurance company issuing the annuity, making the financial strength of the insurance company behind the annuity very important.

How your EIA participates in the returns of the stock market is probably the least understood feature of an EIA. That is because there are so many different ways the insurance companies provide that participation. First, you need to know what on index the participation is based. Is it some portion of the S&P 500, the NASDAQ, the Dow Jones Industrial or some other measure of the stock market’s performance? There is no standard and this will vary from contract to contract.

You will be able to participate in the positive returns of the stock market only to a certain point. EIAs will not credit the contract holder 25% when the market goes up 25%. Returns are capped at a certain percentage. The cap (or maximum return) and how that cap is calculated vary from contract to contract. Some contracts base the cap on the monthly returns of the market, others the yearly returns and still others cap the returns over the life of the annuity contract. The cap method used can have a dramatic effect on the returns of the annuity depending on the stock market’s pattern of returns.

Another feature which differs from EIA to EIA is when the interest from the stock market is credited to your account. Some will credit the interest on a yearly basis; others will not credit the interest until the contract has been in force for a specified amount of time (which may be five years or more). Still others make the contract holder annuitize the contract to receive the stock market interest.

As with almost all annuities, EIAs have a surrender period. A surrender period is the amount of time the owner is required to hold the annuity before they can withdraw their money without penalty. Some EIAs have surrender periods of nine years or more. Of course one danger is that the contract holder will need the money before the surrender period is over. Can you really be certain you won’t need your money for nine or ten years?

As you can see, these dinner invitations, and the products they are designed to promote, may not be all that innocent. The dramatic headlines and inflammatory bullet points in the dinner invitations are designed to raise doubts and create uncertainty. The presentations, whether on Equity Indexed Annuities, Living Trusts, Long-Term Care, or anything else, promise to eliminate that uncertainty. At Bill Few Associates, we have already addressed these concerns in your financial plan and regular review meetings. If you still have questions, be sure to ask your consultant.

There is an old saying that goes “if the only tool in your tool belt is a hammer, then everything is a nail.” Unfortunately, many of these dinner presentations operate under this premise. So the next time you receive one of these invitations, call a friend and go dutch treat instead.