When was the last time you felt really good about a financial product you purchased? Chances are that, if you’re an equities buyer, unless the stock continued on an upward cycle (which quite frankly is pretty rare), you may have had some doubts about your investment.
The same can hold true with annuities. While the opportunity is there to gather a nice gain, along with the added benefit of guaranteed lifetime income, these financial vehicles may not necessarily perform the way you expect them to.
But, by having a more in-depth understanding of how they operate, you can reduce the chances of unpleasant surprises, and instead focus on how the annuity fits in with your overall short- and long-term financial goals.
Dissecting the Fixed Indexed Annuity
With a fixed indexed annuity, or FIA, there are actually a couple of components that come into play when determining the return. One is a declared rate, and the other is the index strategy. For instance, the annuity’s declared rate is an interest rate that is set for the fixed strategy. In this case, you will receive that rate throughout a certain term – which is usually set for one year – and the declared rate will not change during that time period, regardless of what happens in the market.
On the other hand, the indexed strategy is based upon the performance of an underlying market index. One of the more common indexes that are tracked with fixed indexed annuities is the S&P 500.
Typically, at the time that you purchase a fixed index annuity, you are able to decide upon which of the indexes (if there is more than one option available) the annuity’s value will be allocated to.
In addition, you are also typically able to choose which type of crediting method will be utilized in tracking the changes in your chosen index(es). There are different factors that are involved in tracking these changes which can include a(n):
- Cap – There are certain types of FIAs that will set a maximum rate of interest – also referred to as a “cap” rate – that the annuity can earn within a certain period of time. Should the fixed index annuity holder choose an index that its increase is more than the cap amount, then the cap rate is used in determining the annuity holder’s maximum return for that period. The specified periods of interest calculation may be either monthly or annually.
- Participation Rate – A fixed indexed annuity’s participation rate will determine how much of the underlying index’s increase will be used in computing the indexed interest rate.
For instance, if the annuity uses a participation rate of 100 percent, then the annuity would receive 100 percent of the indexed interest that is achieved within a certain time period.
But if the participation rate is 50%, then you would only achieve 50% of what the underlying index earned in that period. As an example, if the index returns 8%, and the participation rate is 50%, then the return would only be 4%.
- Spread – With some fixed index annuities, the indexed interest amount will be determined by subtracting a certain percentage from any gain that the underlying index achieves within a certain period of time. For instance, should the annuity have a spread of 4 percent and the index increases 9 percent during a given time period, then the annuity will be credited with a 5% return for that time frame.
The Power of Zero with Fixed Indexed Annuities
While there are several “moving parts” when it comes to interest crediting on fixed indexed annuities, one thing is for sure – you won’t lose money when you purchase an FIA. This is the case, even if the underlying index performs poorly.
Should the index (or indexes) being tracked return in the negative, the annuity is simply credited for that time period with a 0%. This, in turn, enables your funds to continue upward if or when the underlying index performs in the positive again. And this can occur without having to make up for any previous losses.
Does a Fixed Indexed Annuity Make Sense for You?
Even with the opportunity for growth and the protection of principal, a fixed indexed annuity may not be right for everyone. Plus, not all FIAs are exactly the same. So, before you make a long-term commitment, talk with an annuity expert who can show you what you can anticipate if you move forward.
At Annuity Gator, our goal is to educate consumers on annuities and how they work. We’ll help you wade through all of the technical jargon and fine print that can oftentimes be as “clear as mud”. Contact us and set up a time to chat with one of our annuity professionals.