Given the extreme market volatility over the past decade or so, many investors have become a bit more leery about committing a large percentage of their savings to equities…and rightly so. In fact, if you lost a significant portion of your portfolio in the 2008 recession, there’s a good chance that your assets still haven’t recovered.
This fear over “disappearing” assets has led a myriad of individuals towards a “flight to safety” – particularly those who are at or nearing retirement. Yet, a guaranteed rate of return can also come with some tradeoffs.
For instance, while these “safer” investments won’t technically fall in value, there are some other areas where you can experience significant losses, such as reduced purchasing power down the road.
Enter the fixed indexed annuity, or FIA.
What are Fixed Indexed Annuities?
Fixed indexed annuities are a type of insurance contract that have often been touted as the “best of all worlds.” These financial vehicles can provide you with the ability to earn a higher return than a regular fixed annuity, while at the same time keeping your principal safe, even if the market takes a downward spiral.
Similar to with other types of annuities, the growth that takes place in the FIA account is tax-deferred, meaning that it earns a return on your contributions, as well as on the growth, and on the amount that would otherwise have been paid out in taxes. This, in turn, can allow your money to grow and compound faster.
On the other hand, if the market takes a nosedive, fixed indexed annuity owners can still rest easy, as the principal in the account is simply credited with a 0%. So, while there may not be any gain, there is also no need to worry about a 10% or 20% hit – which of course would require you to build your funds back up to even again over time.
Just like with other types of annuities, an FIA can provide you with a set amount of income – including a lifetime income option that will continue paying out for the remainder of your (and possibly even your spouse’s) lifetime, regardless of how long you may need it.
There are some fixed indexed annuities that provide added benefits, too, like penalty-free withdrawals if funds are needed following a terminal illness diagnosis, or to pay for a stay at a skilled nursing facility. In addition, many FIAs will also include a death benefit that is paid out to a beneficiary if all of the paid-in contributions have not yet been returned when the annuitant dies.
So, given all of these benefits, what exactly is the catch?
How Do Fixed Indexed Annuities Work?
Given the plethora of features that an FIA can provide, the inner workings of these financial vehicles can be somewhat complicated. In fact, of all the different types of annuities, the fixed indexed version comes with an array of small print that outlines just exactly how the product works, along with the various “tradeoffs” that must be made in order to attain the benefits.
First, the way in which your return is calculated is based in large part on the performance of an underlying market index, such as the S&P 500. If the index performs poorly in a given year, no loss will be credited to your contract. However, if the index has a stellar performance, many fixed indexed annuities will credit only a portion of that gain, up to a stated cap or participation rate (i.e., a set maximum).
So, for instance, if a fixed indexed annuity has a cap of 5%, and the underlying index returns 8% for a given period, the annuity’s return will only be credited with 5%. If the index returns 3%, the annuity will likewise be credited with 3%. If, however, the index returns a negative 20%, the annuity will simply be credited with 0%.
As with other types of annuities, you will also incur a withdrawal penalty if you access more than a certain amount (usually 10%) of the contract’s value over a set number of years. In fact, some fixed indexed annuities will impose surrender periods of 10 or 12 years. With this in mind, it is important to consider an FIA a long-term financial endeavor.
Is a Fixed Indexed Annuity Right for You?
Even with all of the moving parts, a fixed indexed annuity could provide you with a way to ensure that your money is safe and that you won’t have to worry about running out of income – even if you enjoy a lengthy retirement.
Truly understanding fixed indexed annuities, though, can oftentimes take asking some in-depth questions. In addition, because all FIAs are not exactly the same, it can help if you work with an annuity expert who can help you to narrow down which one(s) may or may not align with your specific objectives.
At Annuity Gator, our focus is on educating consumers about how annuities work. We make shopping for an annuity easy because we’ve already done all of the legwork. If you’d like more information on how fixed indexed annuities work, or you’d like to compare different annuities so you’ll know what to anticipate, contact us and set up a time to chat.