Fixed Annuities —
How do they help protect us?

Let’s look at a hypothetical example. John and Kathy might have controlled their sensitivity to investment loss by purchasing a fixed income annuity with a portion of their assets.

The two lines on the graph show the assets remaining at the end of each year, after taking into account withdrawals, earnings experience and annuity payments. The value of the income annuity is not illustrated because it cannot be cancelled and has no account value. The value of the annuity is in its guarantee of income that cannot be outlived.

We make the same assumptions on withdrawals from the retirement assets as in the previous case study.

Red Line: As before, the red line shows the assets remaining at the end of each year, if all assets earned the actual annual returns on the S&P 500 Composite Stock Index from 1971 through 2005. Savings run out in year 22 of the 35 year income plan.

Green Line: The green line shows the assets remaining each year if Kathy and John bought a fixed income annuity contract in 1971 covering both their lives, with 40% of their assets ($120,000). The remaining 60% of their assets ($180,000) earned the actual returns of the S&P 500 Composite Stock Index as before. We assume the annuity paid annual income of $10,000 reflecting the 1971 market. The remainder of Kathy and John’s income is furnished by their remaining assets. In this case, the green line shows that buying the income annuity is a smart decision. John and Kathy’s assets and income now last for the full 35 years! In effect, the income annuity “insured” that their other assets would provide the balance of the income they needed. The protection of the fixed income payments from the annuity contract helped to strengthen their income plan for the entire intended period.

Our hypothetical illustration is intended to show the benefit that an income annuity can have on the stability and success of an income plan for a long retirement. We have kept the example fairly simple, for instance, by deducting the income ($15,000 in year 1, $15,450 in year 2, etc.) at the beginning of each year, instead of monthly or weekly.

Here is an example of a hypothetical Index Annuity contract that worked out well:

Mary is now 10 years from retirement. Looking forward, she is concerned that the value of her retirement accounts may decline because of market volatility. Because the time she will start withdrawing from her assets is growing closer, she is looking to transition $100,000 of her assets into fixed alternatives that can protect her assets and the interest she expects to earn. She considers an index annuity contract because it offers the protection she wants.

Mary isn’t ready to start income payments; she just wants protected accumulation for the foreseeable future. While safety is paramount, Mary desires a product that offers attractive fixed interest growth potential.

The following hypothetical chart illustrates how the account value is both protected and increased in the index annuity she is considering.

Red line: This is Mary’s account value in the hypothetical index annuity, from year to year, for the period illustrated. The hypothetical index annuity credits as interest 100% of the annual increase in the S&P 500 Composite Stock Index, up to a maximum (cap) of 8%.

Light Blue Bars: This is the percentage increase in the S&P 500 Composite Stock Index from year to year for the same period.

Under the hypothetical index annuity, Mary’s account value is guaranteed by the insurer to never decrease from year to year (except on account of withdrawals); so in years 3 and 4 when the S&P 500 Composite Stock Index experience was negative, Mary’s account value remained constant at $112,270. On the other hand, in year 2, when the S&P 500 Composite Stock Index increased by 12%, the interest credit to Mary's account was “capped” by the contract at 8%.

This illustrates that Mary’s index annuity offers a guarantee against any loss in account value due to adverse market experience, from year to year, and credits 100% of the gain of the S&P 500 Composite Stock Index up to a maximum (8% is assumed here) in positive years.

This hypothetical example is intended to describe the basic concept of a simple index annuity:

• Interest is linked to the actual annual S&P 500 Composite Stock Index.
• Your account is fully protected against losses for those years when the index return is negative.
• You may receive less than the full return when the index return is strong.
• Though not illustrated, these contracts limit withdrawals in the early years of the contract by charging withdrawal fees.

There are two other important facts to consider in this hypothetical example:

• The type of index annuity illustrated is a fixed annuity issued by an insurance company. It does not directly participate in any stock or equity investments, even though the interest credits are linked to an index return.
• Tax effects were ignored in our hypothetical. For example, neither the advantages of tax deferral, nor the disadvantages of the additional 10% tax penalty for withdrawals prior to age 591/2 were considered.