Fixed indexed annuities can be very useful investments. As the name implies, FIAs are fixed annuities with a rate or return linked to the performance of a stock market index (often the S&P 500). Because of this stock market exposure, they can sometimes bring conservative investors very nice returns – often, considerably better returns than the ones provided by CDs, bonds, or money market accounts. They really aren’t designed to outperform the stock markets; they are designed to outperform the fixed markets.
Principal protection and a chance to benefit from market gains. During the accumulation phase of an FIA, you have the opportunity to benefit from stock market gains while your principal is protected against stock market losses. The annuity contract usually guarantees you a minimum rate of interest on your purchase payments while the annuity is growing; the insurance company involved will credit you with either the minimum return stated in the contract or a return based on the performance of the linked index.
If you are skittish about the stock market, you can potentially realize the benefits of stock market participation through this comparatively low-risk investment. If the linked stock market index has a bad year, you don’t incur a loss.
Participation rates to note. Each FIA has a particular participation rate. The participation rate signifies the percentage of the invested assets within the annuity keyed to the linked index.
Let’s say you have an FIA linked to the S&P 500 and the participation rate is 60%. That means 60% of your invested assets are exposed to the index. If the S&P 500 gains 10% across a year, this means your annuity gives you a 6% return for the year (before any fees and administrative charges). Compare that 6% potential return to so many CDs and money market accounts which often return substantially less.
Some FIAs measure an index’s gain on an annual basis, others over the entire term of the annuity. Sometimes there are “caps” on just how high a return you can realize. From time to time, participation rates may be reset by the insurance company. Occasionally, a margin or “spread” determines the index-linked interest rate instead of a participation rate (if your annuity gains 10% and the spread is 2.5%, your interest-linked credit is 7.5%.).
Tax-deferred growth, an income stream & often a death benefit. Most FIAs give you all the features of a fixed annuity: your earnings are not taxed, and when the distribution phase of your annuity starts, you can receive periodic (usually monthly) income payments. (It is your withdrawals that are taxed.) There is often a guaranteed minimum death benefit payable to your beneficiary when you pass away.
No annual contribution limit. If you need to put away more retirement savings NOW, the contribution limits on IRAs can be frustrating. Would you rather have a retirement account you can only put a certain amount into annually, or an account to which you can contribute as much as you want?
FIAs (and other annuities) have no IRS-imposed contribution ceiling, and no IRS-imposed income limits above which you cannot contribute. Consider them as nice complements or supplements to (not replacements for) IRAs and basic employer-sponsored retirement plans.
Make no mistake, these are long-term investments. Many of these annuity contracts are 6-7 years or longer. If you need to withdraw your money from the annuity during the accumulation phase, there is usually a surrender charge and there could also be a 10% IRS penalty. Fixed indexed annuities do require a long-term outlook and a long-term commitment. The fees for FIAs can also be high compared to other investment vehicles.
Would you like to learn more? If you are planning to maintain or improve your quality of life in retirement, maybe you would like to see how fixed indexed annuities can potentially help you. If that’s the case, then ask a qualified insurance or financial advisor about them today.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.