A fixed index annuity is an investment product that offers three guaranteed benefits for investors:
- The account will benefit from gains in the stock market
- You are guaranteed a minimum rate of return by the insurer
- Your investment is protected if the market goes down
If you’re like most people, you may be thinking that this type of investment product offers significant growth without any downside and in almost every case, you’d be right. Since you are reading this article, we’ll assume that you are new to investing or maybe you’ve been at it a while but never did any research on fixed indexed annuities.
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How doe a Fixed Indexed Annuity Work?
Similar to a traditional fixed annuity, a Fixed Indexed is Annuity is an investment product that offers tax-favored growth and is issued by an insurance company. Although it has similarities with a fixed deferred interest rate annuity, the fixed indexed annuity earns interest based on a stock market index like the S&P 500 or the Nasdaq rather than an interest rate specified by the insurer.
The fixed indexed annuity’s growth rate is based on a “cap” set by the insurer, but the product also contains a “floor” that protects the account holder in a volatile market. In simple terms, the insurance company you select is responsible for the risk associated with a down market. Because of the cap and floor contained in this product, your gains will be capped at about 9% (depending on the product) but your account cannot lose any of the principal.
What about Tax Liability?
The earnings in a Fixed Indexed Annuity grow tax-deferred. This means that you don’t have to worry about your earnings being taxed until you elect to withdraw money from the annuity. Although you can purchase your annuity with rollover money from an IRA or a 401k there is no tax advantage of doing so.
What are the Features and Benefits?
Since your contributions and earnings in your account are guaranteed by the insurance company you elect to purchase your annuity from, there is a high degree of safety with a fixed indexed annuity.
You have the ability to review the insurance company’s financial stability since they are monitored regularly by independent rating agencies like A.M. Best, Moody’s, or Standard and Poor’s
Another benefit to consider is that most Fixed Indexed Annuities are considered flexible premium annuities which means that the insurance company will accept multiple deposits (contributions) from the account holder over time unlike a single premium fixed indexed annuity which only allows one lump-sum payment into the account.
Another benefit that the fixed indexed annuity comes with is known as the “free look” period. The free look period is typically a 30 day period starting on the issue date that gives time to reconsider your purchase and return it for a 100% refund for any reason.
Credible Reasons to Consider a Fixed Indexed Annuity for Retirement?
- Earn higher interest rates than traditional investments like CDs, Money Market Accounts or fixed interest annuities.
- No limit on tax-deferred contributions. Account holders can continue contributing to a fixed indexed annuity even when they have maxed out their qualified plans such as an IRA, 401K or pension.
- Take early retirement without a Penalty. If you are younger than 59 ½ and receive a lump-sum distribution from the company 401K profit sharing plan as part of an early retirement package, you can roll those funds into a fixed indexed annuity without having to worry about taxable income. After your rollover is completed, you can then start taking withdrawals that are penalty-free by setting up a SEPP plan.
- Easily Monitored Required Minimum Distributions (RMDs) When you reach age 70 ½ you are required by the IRS to begin taking withdrawals for your IRA or Pension plan. If you are not in compliance with this rule, the IRS can penalize you 50% of the amount that falls short of your RMD. However, if these funds are rolled into a fixed indexed annuity, your insurance company will monitor this for you at no cost thus saving you the fee your accountant or attorney would have charged to do this for you
What Type of Fees Should I Watch out For?
Although fees and charges for managing your fixed indexed annuity will depend on the insurer you purchase your annuity from, there are four fees that are common to annuity products and you need to be aware of them:
- Insurance Charges – These represent your mortality and expense fees along with administrative fees. These fees pay the cost for the insurance guarantees that are included in your annuity along with selling and administrative expenses of your annuity contract.
- Surrender Charges – Your insurance company will set a limit on the number of withdrawals that are penalty-free during the early years of your contract. If your withdrawal activity exceeds this limit you will be charged a surrender charge to cover the expense of commissions the company pays to the insurance agent. Make certain you understand the withdrawal limits so you can avoid surrender charges.
- Investment Management Charges – These are simply fees that may be assessed on the investment options within your contract and are kind of like mutual fund management fees. The prospectus you receive for your annuity should reveal the charges you might incur for the underlying funds selected for your annuity.
- Riders – Riders are simply optional guarantees that you are allowed to add to your annuity. There are several riders available to the account holder and each of them adds an additional cost to your account that will be deducted accordingly.
Getting the Best Value out of Your Fixed Indexed Annuity
It’s certainly a good thing when consumers perform due diligence on investment products they are interested in. Your research should not replace speaking with an investment professional who has years of experience and understands fixed indexed annuities from top to bottom. In most cases, having an insurance professional assist you with choosing an annuity that will be the best solution for your financial circumstances is a better method than taking on risk investments alone.