Many investors have been increasing their allocations to index annuities as a way to reduce market risk while still maintaining reasonable growth expectations. As numerous insurance carriers have recently started offering “uncapped” index annuities, there are now several attractive alternatives to choose from.
Most uncapped index annuities will allow participation in a percentage of the gains of an index (without participation in the losses) and lock those gains in periodically. For instance, $100,000 allocated on Jan. 1, 2008 to a 55 percent participation rate of the S&P 500 and an annual lock-in would have grown to $186,773 by the end of 2017.*
Most contracts will lock in gains every one to three years. Mathematically, it’s always better to lock in more frequently. So why would anyone ever choose a two- or three-year lock-in? Typically, insurance companies can offer higher index participation when lock-ins occur less frequently. For example, there is a popular index annuity that offers both a one- and a two-year option. The one-year lock-in currently allows for 60 percent participation in the index appreciation, but the two-year lock-in offers 90 percent participation.
Since markets generally go up, the two-year lock-in with higher participation would have produced much higher returns over long periods of time than the one-year lock-in.
However, if there is a really bad year, the two-year lock-in may not start producing any gains until the two-year term is over and a new reset occurs, whereas the one-year reset would have the opportunity to make money after just one flat year. One strategy is to use an index annuity that offers both options. The investor can start with an annual reset and if there is ever a really bad year, there would be the opportunity at the anniversary to switch to the two-year reset and attempt to capture a higher percentage of a potential rebound.
*Safe Harbor Financial
There is a universal disclaimer that warns investors not to assume that the recent results of any particular investment will continue into the future. Despite this warning, when contemplating potential investment strategies, investors tend to place excessive weight on recent performance. After all, who wants to invest in a fund that lost 20 percent in the past year? That is why fund managers will typically promote recent performance if the recent results have been positive.
Sometimes a fund will have noteworthy performance simply because it was part of an asset class that performed well. If you owned virtually any technology fund in 1999, you probably enjoyed great returns but the same fund probably fared very poorly in 2001 and 2002. If you were looking for a “hot” investment in 2012 you might have noticed how much gold had gone up over the prior eight years. However, since then, gold has performed very poorly.
For decades, conservative investors have been relying on bonds to add stability to their portfolios. For many years, bond funds had delivered impressive, stable, conservative returns. Those funds benefited from a bond-friendly interest rate environment that had mostly been falling — until this past year, at least. A falling interest-rate environment is ideal for bonds.
The question you must ask yourself as a potential investor is not “what was the 10-year track record of the fund?” but “what are the market conditions that exist today and are they conducive for this particular investment?”
The reality is whatever happened recently seems so obvious in retrospect, yet most people are unable to accurately predict which funds or asset classes will be the top performers in any given year. Therefore, it’s advisable to create a diversified portfolio with numerous non-correlated asset classes, and to resist “chasing” the recent hot asset class.
On this Father’s Day, I want to share with you the first financial lesson my father tried to teach me. When I was in the second grade, the public school lunch in the Philadelphia school district cost 60 cents. It included a protein, a milk a vegetable and dessert. One Monday before school, my father tried to teach me about money management.
He handed me a five-dollar bill (probably because he didn’t have any change) and said this money is for lunch for the week. At lunch that day, I paid for my meal and the cashier gave me back my change. I was flush with cash and my friends and I were hungry for dessert. I treated my friends to brownies and chocolate chip cookies. I was very popular. My generosity continued the next two days; my friends and I continued to enjoy desert after lunch.
Unfortunately, by Thursday morning I was out of cash and I approached my dad for more lunch money. I don’t know exactly what his expectations were of a 7-year-old’s money management skills, but he acted very surprised and disappointed when I told him I was broke. I explained that I had spent a lot of the money buying my friends desserts and he grounded me for the rest of the week.
Thankfully, my father was nice enough to give me more lunch money and I learned a valuable lesson in budgeting. When you are young and you make poor financial choices there is still time to recover. However, once we approach or enter retirement, poor money choices can be devastating. We probably won’t have our fathers around to bail us out. My father helped me learn at a young age that without a sound financial plan one’s chances of financial success are greatly diminished.
The Blackstone Group LP has been pitching an innovative tax shelter to its ultra-wealthy clients. Invest your money with us and never pay any taxes. Blackstone, through its subsidiary, is recommending its clients utilize specially designed life insurance contracts to shelter their investment portfolios from state and federal income tax. Traditionally, life insurance policies grow tax-free and allow for tax-free income and death benefits, but its growth has traditionally been linked to low-yielding conservative assets.
The specially designed contracts being touted by Blackstone and other firms that service high net worth clients allow their clients to invest in a wide range of unique investments including hedge funds in a tax-free environment. According to Bloomberg, clients have placed about $3 billion dollars into these types of vehicles in the past year. Some consider this a “loophole” in current tax laws since life insurance has been blessed by Congress with extremely favorable tax treatment to create an incentive for people to own life insurance to protect their families. However, this strategy is designed to eliminate taxes not necessarily to provide life insurance benefits to one’s dependents.
Nevertheless, the prospect of never paying any taxes on dividends, interest, capital gains or distributed income is very appealing to those who dislike paying taxes even with historically low tax rates. Although, the strategy has been around for decades, if tax rates rise in the future, the demand for strategies that help avoid income taxes should only increase. For customized “private placement” life insurance with your own personal choice of investment offerings, there is usually a minimum account size of a couple million dollars. However, for those investors who aren’t “ultra-wealthy” but still would prefer not to pay any income taxes on their investments, there are similar “off the rack” strategies available using more conventional investments.
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