The truth about fixed-index annuities
Misperceptions vs. Realities
When it comes to annuity products, fixed index annuities (FIAs) have been around for a relatively short period of time. Created in 1996, FIAs are insurance products, not investments. FIAs offer the opportunity for some interest potential while protecting against market risk. However, as with many new ideas, misperceptions abound.
Misperception #1: FIAs are too complex to understand
This hypothetical example is provided for illustrative purposes only and does not reflect any surrender charges or rider fees that may be assessed. If there is no indexed interest, the value would be the money you put into the annuity.
Reality: Understanding FIAs may involve learning a few new… but basic terms. As with traditional fixed annuities, FIAs offer interest accumulation based on changes in an external index. Only positive movements in a benchmark stock market index. There are various ways by which you earn interest, referred to as “interest crediting options” or “allocations choices,” and these will be calculated in a few different ways.
- FIAs offer the potential to earn more interest than that offered through traditional fixed rate annuities. Interest earned is based on a portion of the positive annual changes in an external benchmark index, such as the S&P 500®. Simultaneously FIAs provide protection from market declines, as negative index performance equates to a “zero%” interest credit.
Standard & Poor’s 500® Index (S&P 500®) is comprised of 500 stocks representing major U.S. industrial sectors. Performance figures are inclusive of dividends reinvested. S&P 500 is a registered service mark of Standard & Poor’s Financial Services LLC. The product is not sponsored, endorsed, sold, or promoted by Standard & Poor’s and Standard & Poor’s makes no representation regarding the advisability of purchasing the product.
- Credited interest are protected from loss of principal due to market declines
- As we talk about a benchmark index, understand that at no time is money invested directly in the stock market. One does not actually own any stocks, bonds, index funds, or other investments. The positive changes in the external benchmark index are only used to help determine the interest rate that will be credited.
- Insurance companies offer resources or product material to help ensure a full understanding of FIAs, to help people make informed, educated financial decisions.
- Fixed-indexed annuity products, (FIAs) offer traditional annuity benefits including tax deferral, a guaranteed minimum value, a death benefit, and the option for guaranteed lifetime income.
- The mechanics of the FIA, as compared to the benchmark index itself, appear in the picture below. The red line represents the hypothetical ups and downs of the market or benchmark index, and “The green line represents the accumulation value of the contract. It can increase, subject to contract limits, based on positive movements in the index. However, when the overall index is negative, no accumulation is lost. This feature is commonly referred to “annual reset.”
- A guaranteed minimum value, credited with interest at a guaranteed rate is represented by the blue line.
- Guarantees are backed by the financial strength and claims-paying ability of the issuing carrier. Product and feature availability can vary be state and carrier.
Misperception #2: FIAs have high fees.
Reality: Like many financial products, FIAs carry some fees. The insurance company uses these fees to help support its guarantees and provide valuable benefits including:
- The potential for interest based on changes in an external index. FIAs provide purchasers with the opportunity to benefit from a portion of a market index increase without directly participating in the market. They never participate in stock market downward movements.
- Protection from loss of principal if the market index declines is a key component of the FIA.
- Like most other annuities, FIAs can be converted into a stream of guaranteed lifetime income. But some FIAs provide lifetime income options without annuitization through additional, add-on features called riders. Note that there is typically a fee associated with income riders. Which means you keep your principal and interest gains intact in your account value, still providing the opportunity to earn interest each year, even after you have chosen to exercise your lifetime income rider. This provides consumers both an income stream, and the opportunity to do something else with their remaining account value, should they choose to do so.
- Keep in mind most annuities have surrender charges for a period of 7-10 years, so if you do choose to liquidate or transfer you annuity’s value, a surrender charge may apply if doing so within the surrender charge period.
Product and feature availability may vary by state and broker/dealer.
Misperception #3: FIAs tie up your money for years.
Reality: Many contemporary FIAs have surrender periods of 10 years or less.
- Some of today’s FIAs have surrender periods as short as five years.
- Most annuities give you access to at least a portion of your money, such as 10%, after the first year with no surrender charges or other contract penalties.
- Many FIAs offer multiple ways to access funds without penalties.
- Features, such as penalty-free withdrawals, loans, nursing home provisions, and full accumulation value paid to beneficiaries at death before annuity payments begin, are now common.
Early withdrawals may result in loss of principal and credited interest due to surrender charges
Any distributions may be subject to ordinary income tax and, if taken prior to age 59 1/2, an additional 10% federal tax.
Misperception #4: FIA values must be annuitized.
Reality: Most FIAs offer multiple ways to access accumulated values without taking annuitization.
- While some contracts have certain values that may be available only through annuitization, most current product designs allow for lump-sum access after the surrender charge period. Many offer the option (either built into the contract or available as an optional rider with an additional cost) for a guaranteed lifetime withdrawal stream. Withdrawals will decrease the contract’s values, including the future income value and any death benefit.
Misperception #5: If you die, the insurance company keeps all of your money.
Reality: FIAs let you choose a beneficiary.
- Your beneficiary will be entitled to receive your contract’s death benefit if you die before you start taking annuity payments, or if annuity payments have been initiated, to receive any remaining guaranteed payments under certain annuity options, in lieu of a death benefit.
- The exact amount the beneficiary receives will depend on the terms of the contract, but most current product designs provide a death benefit equal to the accumulation value, which reflects the interest credited to the annuity as well as any previous withdrawals or amounts deducted from the annuity. Some FIAs provide an enhanced death benefit, which can be greater than the accumulation value (see particular product offerings and disclosures for details).
A FIA may be a good solution.
The reality is, with the volatility of the financial markets in recent years – combined with the limited availability of retirement income sources such as pensions – Americans have greater individual responsibility when it comes to preparing for their future, for their retirement.
FIAs can be a great addition to an overall income plan, or a retirement income planning strategy, but they’re not right for everyone. Purchasing an annuity is an important decision – and one that should be made only after consulting with a financial professional.
For more complete information about fixed index annuities, please contact a licensed insurance professional.
Distributions are subject to ordinary income tax and, if taken prior to age 59½, a 10% federal penalty tax may apply.
- Not FDIC insured ● May lose value ● No bank or credit union guarantee ● Not a deposit ● Not insured by any federal government agency or NCUA/NCUSIF