A fixed-indexed annuity is a type of fixed annuity that is distinguished by the interest yield return being partially based on an equities index, the S&P 500. For people that are building a retirement plan or are adjusting to their current plan, it is important to understand the value that the insurance industry can provide for some of a person's hard-earned money. Today, annuity companies have more evidence than ever that if managed correctly, fixed-indexed annuities are found to perform as they were designed. It is clear that these insurance contracts not only offer principle protection, (a core benefit for any concerned investor), but also many other benefits, that can enhance the consumer's potential for a better retirement. Since the economic climate now moves at the speed of the internet, it is important to utilize these tools that can help cope with the risks that affect the lives of millions every day. Many of these new protections include the ability to reduce high volatility, moderate to attractive growth in upside market periods, competitive management fees and rider costs, the ability to adapt to changing market conditions, as well as substantial death benefits, enhanced liquidity, long-term care protections, and viable income strategies for clients entering the distribution phase of retirement. The general appeal of fixed-indexed annuities is to moderately conservative investors who like having some opportunity to earn a higher investment return than what's available from traditional fixed-rate annuities or certificates of deposit, while still having full protection against downside risk. How a Fixed-Indexed Annuity Works an annuity is essentially an investment contract with an insurance company, traditionally used for retirement purposes. The investor receives periodic payments from the insurance company as returns on the investment of premiums paid. There is an accumulation period when the premiums paid earn interest in accordance with the terms of the annuity contract, followed by a payout period. Some annuities are purely for accumulation, death benefits, and even long-term care. In the case of fixed-indexed annuities, a part of the interest rate earned is a guaranteed minimum, typically 1% to 3% paid on 90% of premiums paid. The other part is linked to the specified equities index chosen at the beginning of each anniversary year. Earnings from fixed-indexed annuities are usually higher than traditional fixed-rate annuities, lower than variable-rate annuities, but with better downside risk protection than variable annuities usually offer. Special Considerations A key feature of fixed-indexed annuities is the participation rate, which basically limits the extent to which the annuity owner participates in market gains. If the annuity has an 80% participation rate, and the index to which it is linked shows a 15% profit, the annuity owner participates in 80% of that profit, realizing a 12% profit. Par Rates vary from 100% to as low as 40% of an index' performance. In return for accepting limited profits, investors receive protection against downside risk, usually a guarantee of at least breaking even each year that interest is earned in terms of the equity index portion of earned interest. Some equity annuities also have an absolute cap on total interest that can be earned. Another aspect to consider is whether or not interest earned is compounded. Indexed annuities use one of three calculation formulas to determine the changes in the equity index level that interest payments are calculated from. The most common is the annual reset formula, which simply looks at index gains and ignores declines. This approach can be a substantial benefit during down years in the stock market. A second formula, the point-to-point method, averages the index-linked return from the index gains at two separate points in time during the year. The third option, the high-water mark, looks at the index values at each anniversary date of the annuity and selects the highest index value from those to then be averaged with whatever the index value was at the beginning of the payment term. Limitations of Fixed-Indexed Annuities One disadvantage of equity-indexed annuities is surrender charges. If the annuity owner decides to cancel the annuity and access the funds early or before the age of 59½, cancellation fees can run high, in addition to a 10% tax penalty. After age 59 ½, owners can take 10% free withdrawals if they desire. Historically, fixed-indexed annuity companies pay commissions to the advisor or insurance agent that sold the product to the consumer. If the cost of the commission is divided by the length of time that the agent or advisor serves the client, the costs are actually very competitive, as each year the agent helps the consumer manage the annuity. Fixed-indexed annuities are complex and there are numerous factors that can significantly affect the investment's potential profitability. Some analysts who are biased to moderate to high-risk investments question whether these annuities can be considered a good investment at all. Like any investment, it's key to understand how fixed-indexed annuities work, and the risks involved, before deciding to purchase one. There are pros and cons to these types of annuities. These annuities often carry surrender charges. At the end of the day, it's the insurance company and underlying guarantees that are important. Fixed-Indexed Annuities are fixed-principle assets. These assets cannot lose money if managed correctly during the accumulation phase. They are moderately liquid. An owner of an annuity can withdraw funds in a number of ways. It is best to look at IRS tax laws to navigate when to take these withdrawals. A financial professional can guide you as to how best to take a withdrawal during an accumulation period. During a distribution phase, the owner can take income distributions in a number of ways, including a lifetime income benefit which was predetermined at the time of purchase. Some of these income benefit riders have no charges while others have charges for guarantees built into that rider.
Modern Day annuities often times are strong tools to build tax-free income plans. Often times it is advantageous to create a Roth IRA Annuity, so that income will always be tax free for the owner's life, and even for the transfer of wealth to the next generation tax-free. In addition to tax-free income, some fixed indexed annuities have increasing income options available in the contract. Part of the value of owning an annuity is the ability to enhance your growth thru indexing strategies that are developed by world renowned financial experts. The allure is to enjoy the upside potential of these indexes, while never putting your principle or growth at risk. It is possible in good years to receive double-digit gains, but most years annuities are designed to offer reasonable returns. Remember there is never any market downside credited. Clearly moderate returns are valuable in turbulent economies. Inflation is one of the biggest threats to growing and preserving your wealth and income. If inflation is running at 3-5% annually, it is important that these vehicles outpace inflation. Indexes help to keep up with or outpace inflation. Indexes are designed differently to achieve a particular result. Indexes are external, and not directly-linked to the market. At the beginning of a crediting period to the end of a crediting period is when the performance of each index is measured as to whether an interest payment will be made to the account. If you were in the market directly you would be subject to potential for heavy losses, which could reduce the ability of a person to live reasonably during their retirement. That is precisely why millions use annuities.
Principle and gains are always protected, as the insurance carriers carry the burden of risk on their shoulders. People can pay a high price for liquidity control. That is another reason to used fixed-indexed annuities. Alpha is the outperformance of a portfolio that the fund manager brings, knowing what to buy, when to buy, and when to sell. So, where is a retiree supposed to get alpha in a low interest rate environment? The market is too volatile for the average investor to handle. People need retirement Alpha. A portfolio with a lifetime income annuity will outperform a traditional 60/40 portfolio much of the time. Don't take anyone's word for it. Research from the Financial Research Center of Boston says to add an income annuity to a portfolio. Remove the bonds from a portfolio, and add an income annuity with the equivalent of a AAA Rated Bond Index, with a Triple C Rated Yield, and a 0-standard deviation, and the portfolio will have lower risk and increase in returns. Income annuities offer features other investments often can't- high cash flow, uncorrelated to market returns, retirement alpha in the form of mortality credits, which only life insurance companies can manufacture: longevity hedging and liquidity features. Alpha again is the extra return that a portfolio manager brings to the performance.
In low interest rate environments, cd's, bonds, are not going to give the "alpha" necessary to provide adequate income. Stocks are so volatile that most retirees do not want to put all their money at risk and the order of returns lock in losses for people planning to retire or that are already retired. Indexed annuities can protect the portfolio for a better withdrawal strategy. Consumers need to be educated enough to have reasonable expectations about how an annuity can perform. The best way to have best results is to have semi-annual or annual reviews with your insurance or financial advisors that placed you in your contract. These professionals will guide you in management of the annuity in all phases of your life in the contract.
