Throughout the years, there have been many different financial vehicles that have been introduced for the purpose of helping to meet the needs of consumers who require income in retirement.
One of the most recent of these is the fixed indexed annuity or FIA. Unlike a regular fixed annuity, the FIA has its growth linked to an external reference or index. This means that the value of the FIA is correlated to a market index such as the S&P 500 or the DJIA (Dow Jones Industrial Average). Because of that, the way that an FIA credits the return will differ significantly.
How Exactly Does A Fixed Indexed Annuity Work?
In many ways, a fixed indexed annuity will work in a similar fashion to a regular fixed annuity. First, there are similarities in that there are three parties to the annuity. These include the:
- Insurance Company – As with other types of annuities, fixed indexed annuities are offered by insurance carriers. The underlying insurer will be responsible for guaranteeing the annuity’s payout.
- Owner / Annuitant – Often the owner and the annuitant are the same person – but they do not have to be. The owner will make the primary decisions regarding the annuity. The annuitant is the person whose life expectancy the annuity income payment is based upon.
- Beneficiary – The beneficiary is the person who will receive the annuity’s death benefit. More than one beneficiary may be named. This is important because without naming a beneficiary, the annuity’s funds could be subject to the expensive, time consuming, and public process of probate.
However, because of the fact that an FIA is linked to an underlying market index, there are some primary differences as well. Also, the interest earnings in an FIA are also locked in each year – up to a stated cap – and they will therefore not incur any type of negative index return during down market periods. What this means for the holder of a fixed indexed annuity is that he or she will always have their principal protected from market downturns.
With that in mind, the fixed indexed annuity can provide a win-win situation in that it offers its owner earning potential that is linked to a market index, but at the same time, it protects principal from negative turns in the market.
Technically, FIAs are an insurance contract between an individual and an insurance company – just like other types of annuities. In exchange for either a lump sum deposit or a stream of regular or sporadic deposits, the insurance company will in the future provide the individual with a stream of income.
Fixed indexed annuities can be either immediate or deferred. This means that the owner of the annuity can choose to take his or her income immediately (or very soon after making their deposit), or at a time to be determined in the future.
The funds that are inside of a fixed indexed annuity are also allowed to grow on a tax-deferred basis – which allows them to grow and compound without being taxed each year on the growth, until the time they are withdrawn.
It is important to note that the owner of a fixed indexed annuity is not investing their funds directly into the market – and because of that, these vehicles are considered to be much safer that investing in stocks or mutual funds. In fact, due to the fact that FIAs are insurance contracts, they are able to guarantee the safety of their holders’ principal, as well as provide them with a minimum rate of return.
With that in mind, FIAs can guarantee that the value of the annuity’s holder’s account will never be less than the total of their deposits – while at the same time offering them the opportunity to exceed the fixed rate of return that is being offered.
Return Components In A Fixed Indexed Annuity
When you purchase a fixed indexed annuity, you will typically be able to choose which of the indexed that your annuity’s value will be based upon. Also, you will be able to choose which type of crediting method will be used in tracking the changes in your index (or indexes, if there is more than just one).
The factors that are typically available for tracking an FIA’s return will include the following:
- Cap – The cap rate is also known as the maximum rate of interest that the annuity holder can receive in his or her FIA within a given period.
- Spread – Some FIAs use a spread in determining the return. Here, the FIAs return will be determined by subtracting a certain percentage from any gain that the underlying index achieved within a certain time period. As an example, if the FIA has a spread of 5%, and the annuity increased by 9%, then the FIA will be credited with 4% indexed interest.
- Participation Rate – The participation rate will determine how much of the underlying index’s increase will be measured in computing the indexed interest rate. As an example, if the annuity holder’s FIA used a participation rate of 90%, then the annuity would get 90% of the interest that is achieved within a certain period.
With a fixed indexed annuity, there are also different ways of crediting interest to the annuity. These can include the following:
- Annual Point-to-Point – When using the annual point-to-point method, changes will be tracked in the underlying market index from one contract anniversary to another. Interest will then be credited to the FIA based upon that annual change.
- Monthly Sum – If the monthly sum method is used, then the individual monthly increase and decrease in the underlying index values will be tracked and added up. The sum can help with determining the indexed interest that can be credited to the annuity.
- Monthly Average – If the monthly average is used, then individual monthly values of the underlying index – or indexes – will be totaled. Then, the total will be divided by 12 so that the monthly average can be determined.
Benefits Of Owning A Fixed Indexed Annuity
Given that today’s stock market continues to remain a roller coaster, a fixed indexed annuity can provide investors with a nice alternative. Just some of the many benefits that can be obtained from owning one of these financial vehicles may include:
- Growth Opportunity – The opportunity to grow your funds can is one advantage of a fixed indexed annuity – especially over a regular fixed annuity. This is because the FIA is linked to various market indexes that could provide you with a substantial amount of growth.
- Safety of Principal – In a down market year, the fixed indexed annuity provides you with safety of your principal. Therefore, rather than seeing a negative on your statement, you are simply credited with a 0%. This can also provide you with the added benefit of not having to make up for investment losses and getting back to a breakeven point.
- Tax-Deferred Growth – As with other annuities, fixed indexed annuities will also allow the tax-deferred growth of funds within the account. This can offer a substantial advantage over taxable investment accounts – especially if you plan to hold the annuity for a longer period of time so that your funds can grow and compound.
- Lifetime Income Guaranteed – When the time comes to convert the accumulated funds over into income, a fixed indexed annuity can provide you with a stream of guaranteed lifetime income – regardless of how long you may live. This can help to alleviate the number one fear that is in the minds of many retirees today – that of outliving their savings before they run out of time.
- Bypass Probate – In many instances, your annuity funds can also bypass the costly and time-consuming process of probate at the time of your passing. This can be beneficial to your heirs and loved ones.
- Not Available to Creditors – In most states, annuity funds are also not available to your creditors. Therefore, even if you are sued or file for bankruptcy, these funds could be untouchable.
- Leave a Legacy – A fixed indexed annuity could also allow you to leave a legacy for loved ones. Should you pass on before using up all of the income in the annuity, there are ways to structure the annuity so that a death benefit can be paid out to a named beneficiary.
- Funds for Other Needs – In addition, these annuities can also be structured to pay out funds for additional needs such as that of a chronic illness or long-term care.
How To Find The Best Fixed Indexed Annuity For You
Regardless of whether you are seeking to save for retirement at a great rate of return, or if you are seeking immediate income for your current retirement needs, a fixed indexed annuity could fit in with your particular goals.
When seeking the best fixed indexed annuity for you, it is often wise to work with a company or an agency that has access to more than just one annuity carrier. That way, you will be able to compare the features and the benefits of multiple annuities in a more unbiased manner.
If you ‘re ready to shop for the FIA that best fits in with your specific needs and goals, we can help. We work with many of the top annuity carriers in the marketplace today, and we can assist you with obtaining all of the important information that you may require in making an informed purchasing decision. When you’re ready to move forward, just simply take a moment to fill in the quote form on this page.
Should you have any additional questions about fixed indexed annuities – or even if you just have a question about annuities in general – please feel free to contact us directly, toll-free, by calling 800-376-0824. We want to ensure that you have all of the details that you require. So, contact us today – we’re here to help.