What is an annuity illustration?
If you are presented with, or you purchase an indexed or variable annuity, you may be shown an annuity illustration.
An annuity illustration is a document that projects how the annuity might perform over a given period, how the product’s features might work and how certain circumstances will affect your contract values over an extended period.
The illustration could be set up as a table of values, a line graph or a bar graph. The agent or insurance company will input hypothetical values, which when calculated, will offer a projection of the annuity’s account value after each contract year.
If you purchase an optional income rider, the illustration should also show growth of the rider’s benefit base, which is the value used to determined how much the rider will pay in income.
If you purchase a variable annuity, the projections used in the illustration will be based in part on the actual historical performance of the sub-accounts you can invest in. Variable annuity sub-accounts are mutual-fund-like investments. Like mutual funds, these subaccounts offer different investment options in stocks, bonds, money market funds, and other securities. The money in those subaccounts will increase or decrease over time, depending on their performance.
An indexed annuity illustration will be based in part on the historical performance of the corresponding index.
For example, if you have an indexed annuity that uses the S&P 500 as its benchmark, the illustration will consider the average annual return of the index over a given period, such as the last 20 years. If the corresponding index averaged a return of 6 percent annually over the given historical period, the illustration would assume the index will increase by 6 percent each year you hold onto the annuity.
Of course, markets and indices never move consistently. An index may increase 10 percent one year and decrease 15 percent the next.
Also, some indices are recent creations and therefore there is no historical performance data to establish the index’s projected performance. When this occurs, inquire as to what the projected calculations were based on.
Index annuity illustrations also have to take into consideration the impact of caps and/or spreads.
A cap is a ceiling on interest rate growth. A typical cap might be 8 percent. That means your annuity’s account value can not increase more than 8 percent in any one period, regardless of how much the benchmark index increases. If the index increases 5 percent, your account value will increase 5 percent. If the index climbs 12 percent, the account value will be limited to 8 percent.
A spread, on the other hand, acts more like a floor. If your annuity has a 5 percent spread, your account value will increase by whatever percentage above 5 percent the corresponding index goes up. If the index increases 7 percent, your account value will grow 2 percent (7 – 5). If the index climbs 15 percent, your account value will earn 10 percent. But if the index only increases 3 percent, your account value will gain nothing for that period.
When reviewing an indexed annuity or variable annuity illustration:
Understand that the illustration is just a projection based on historical data. There is no guarantee that what happened in the past will occur in the future; in fact, it’s highly unlikely an investment performs the same over the next ten years as it did the previous decade.
Ask what is guaranteed and what is not — such as fees and expenses — and what assumptions were made to create the illustration.
If you believe the projection are too good to be true, then ask the insurance agent to run less aggressive scenarios.