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Principally Protect ( Asset Protect ) Your Investments

By Roccy M. DeFrancesco, JD, CWPP™, CAPP™ - Email Editor

Date: 26-Jan-2006

Equity Indexed Annuities (EIA)

As I stated in my article last week, my definition of “creditor” is different than most other advisors who say they are asset protection specialists. My definition again is: anyone or anything that can take your money is a creditor.

Who was your biggest creditor when the stock market crashed in 2000-2002? Of course it was the stock market. Did you lose wealth? Many segments of the market went down over 50% (and the S&P 500 went down 43.88%). The “correction” helped millions of people understand that the stock market really does not return 10%+ every year.

Protecting your principal while aiming for growth

Would you like an investment that would never go backwards but had the potential to return 6-8+% a year? If your answer is no, then you do not need to read the rest of this article.

When you buy stocks and mutual funds through your local broker or with your online trading account, do you have any protection? NO.

What is the most popular guaranteed investment for most clients? Certificates of Deposit (CDs). The problem with CDs is that the returns are low and are income taxed every year.

Equity Indexed Annuities

An EIA is a product purchased through an insurance company where the company “guarantees” your principal and invests your money (income tax deferred) with growth pegged to a measuring stock index (typically the S&P 500).

EIAs are both simple and complex. EIAs have various crediting methods which I do not have time to explain in this article (for a full article on EIAs, please e-mail clientservices@trustmakers.com.

Principal protection - If the money was invested in the EIA when the S&P 500 was at 1000 and 365 days later the S&P 500’s value was 1050, the return in the EIA would be 5%. If the S&P 500’s value was 900 (negative 10% for the year), the balance in the EIA would still be whatever the value was on day one.

The most popular EIA is an annual reset EIA. With an annual reset EIA the insurance company values the EIA the day the product is funded and then 365 days later, values it again based on the return of the measuring index. This means every year the gains are locked in. So, if you bought an EIA that went up 5% each year for two years and in the third year the measuring index fell 10%, the value in the EIA would be the value at the end of the second year due to the annual locking feature.

No free lunch

There is no free lunch with an EIA. When you get protection you give up some upside growth. What that means is there are “caps” with most EIAs. The cap will vary typically per year depending upon a number of factors. Generally speaking, the caps over the last five years have been anywhere from 12% to 6%. Therefore, if the S&P 500 index goes up 15% in one year and your cap is 10%, your investment return in the EIA will be 10%.

Example:

The following is an example of what would have happened to money in a 9% annual cap (point-to-point) EIA with principal protection and growth pegged to the S&P 500 from 1992 to 2002 and a comparison to what the client would have had in a typical brokerage account with the same returns. I am assuming the money in the brokerage account had the typical capital gains and dividend taxes levied on the account every year as well as a 1% management fee.

At some point in everyone’s life it is more important to protect the principal than it is to reach for big returns. With EIAs, you can have peace of mind that your money will be protected. At the same time you will know that if the market performs well you will receive returns well above the fixed and annually taxable returns of CDs or money market accounts.

Summary

EIAs should be a tool used by most investors at some point in their lives with some portion of their investment portfolio. Be excited about the topic, but be wary of the people who sell EIAs. While I’ve made EIAs sound like a simple topic in this short article, there are many nuances to them that make one type of annuity much better than another depending on your circumstances. Unfortunately, I’ve seen many times where clients buy the wrong kind of EIA due to the greed of their insurance salesperson.

If you wondered if you have the right EIA or if you have an interest in looking at EIAs to protect some portion of your stock portfolio, please contact clientservices@trustmakers.com for a review of your particular situation.

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