A tired clich? from securities salespeople is to dismiss index annuities by saying you cannot get a competitive return with an index annuity because you do not get the benefit of reinvested dividends and you don't share in 100 percent of the index movement. Unfortunately, all this shows is a lack of understanding of how most index annuities work and where they are designed to fit.
The first problem with this argument is that sometimes the stock market goes down and the non-index annuity client also shares 100 percent in these losses. For example, if the index was down 9 percent the following year the investor would have lost all of the market gains, but the typical index annuity owner would still have 4.2 percent AND the typical index annuity would have reset the index calculation point for new gains.
For the 10-year period ending in December 2007 the S&P 500 produced an annualized return, with dividends reinvested, of 5.9 percent.
If you look at the actual returns of annual reset index annuities with published renewal histories, you find the annualized return for these index annuities bought at the end of 1997 for the ten years ending in December 2007 averaged 5.2 percent. These index annuities effectively gave 88 percent of the index fund return that included reinvested dividends.
The S&P 500 without dividends — which is what index annuities look at — returned 4.2 percent a year. The average annuity participation in some years was less than 50 percent of index gain and yet the index annuity annualized return had effective overall participation for the ten year period of 123 percent.
How is this possible? Because during the three-year, millennium bear market when the S&P 500 dropped by half, these index annuity owners kept their credited interest and bided their time until the bull market returned.