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Annuities
A fixed indexed annuity (FIA) is a contract with an insurance company designed to protect your principal from market losses while providing opportunities for interest growth. Interest is credited based on the performance of a market index, such as the S&P 500, subject to the terms of the contract. Your money is not directly invested in the stock market, so a decline in the index does not reduce your account value.
This article explains how fixed index annuities work, their potential benefits, and important considerations when deciding whether one may be right for your retirement.
At the end of each crediting period, often one year, the insurance company calculates the interest based on the performance of the selected market index.
Importantly, many fixed indexed annuities offer uncapped strategies, allowing for greater interest-earning potential without a fixed cap on returns. Different annuities use different methods to calculate interest. Three common features are:
Uncapped strategies may use participation rates or spreads to determine how much interest is credited.
Example 1 - Capped Strategy (hypothetical): Suppose you select a crediting strategy with an 8% annual cap:
Example 2 - Uncapped strategy (hypothetical): Suppose you select an uncapped strategy with a 120% participation rate:
Why protecting your retirement savings matters
The stock market offers opportunities for significant growth, but it also exposes investors to the possibility of substantial losses. During the 2008 financial crisis, millions of Americans watched their retirement savings plummet. For many approaching retirement, years of accumulated savings were wiped out, forcing some to postpone retirement and continue working far longer than they had planned.
For those approaching or already in retirement, protecting accumulated savings can be just as important as growing them. Fixed indexed annuities offer a way to pursue interest growth while protecting principal and previously credited interest from market downturns.
Fixed indexed annuities protect your principal and previously credited interest from market downturns. These guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company.
While market declines do not directly reduce your account value, certain contract provisions can affect the amount available to you, including:
One of the biggest questions people face as they approach retirement is, "How long will my money last?" In addition to protecting your retirement savings and providing opportunities for interest growth, many fixed indexed annuities offer the option of creating a guaranteed income stream for life.
With an optional income rider, you can choose when to begin receiving payments, helping to provide predictable income throughout retirement, regardless of how long you live. Much like a pension, these payments can provide a dependable source of income for the rest of your life. The amount of income you receive depends on factors such as the amount you deposit, your age, when you begin taking income, and the terms of the contract. If money remains in your annuity when you pass away, it will be passed on to your designated beneficiaries.
Fixed indexed annuities are designed for long-term retirement savings, but that doesn't mean your money is completely locked up.
Most contracts allow you to withdraw up to 10% of your account value annually without surrender charges. You can generally withdraw more than 10%, but amounts exceeding the permitted withdrawal limit may incur surrender charges during the surrender period. These charges typically decrease each year until they are eliminated. These surrender periods help insurance companies manage their long-term commitments while providing the principal protection and potential interest growth offered by fixed indexed annuities.
Some annuities also offer additional withdrawal flexibility for certain circumstances, such as qualifying nursing home stays, hospitalization, home health care needs, or terminal illness.
Fixed indexed annuities offer tax-deferred growth, meaning you don't pay income taxes on interest as it's credited to your account. This allows money that might otherwise be paid in taxes to remain in your annuity, where it has the opportunity to earn additional compounding interest. Taxes are generally due when you withdraw money.
If you fund an annuity with money from a traditional IRA, 401(k) or 403(b), withdrawals are generally taxed as ordinary income. These retirement accounts already provide tax-deferred growth.
If you purchase an annuity with money outside a retirement account, known as a non-qualified annuity, only the earnings are generally subject to income tax when withdrawn.
Withdrawals before age 59 1/2 may also be subject to an additional 10% early withdrawal federal tax penalty, unless an exception applies.
Pros
Cons
A fixed indexed annuity may be worth considering if you are approaching retirement, already retired, or simply uncomfortable with the risks of the stock market and you're looking for ways to protect your accumulated savings while continuing to pursue opportunities for growth.
It may be particularly appealing if you:
Can you lose money in a fixed indexed annuity?
Your principal and previously credited interest are protected from stock market downturns, regardless of how much the market declines. While certain contract charges and withdrawals can reduce your account value, market losses will not.
How is a fixed indexed annuity different from a fixed annuity?
A traditional fixed annuity offers a guaranteed, fixed interest rate for a specified period. A fixed indexed annuity offers opportunities for potentially higher interest earnings based on the performance of a market index, while protecting your principal and previously credited interest from market downturns.
How is a fixed indexed annuity different from a variable annuity?
A variable annuity typically invests in market-based investment options, meaning your account value can rise or fall based on market performance. Variable annuities also generally have higher fees and may include surrender charges. A fixed indexed annuity offers opportunities for interest growth based on market index performance while protecting your principal and previously credited interest from market downturns.
How long is my money tied up?
Fixed indexed annuities are designed for long-term retirement planning, with surrender periods that vary by contract. However, most allow you to withdraw up to 10% of your account value annually without surrender charges. You can access additional funds if needed, although surrender charges may apply during the surrender period.
With over 20 years of experience, Robby Welles, founder of Welles Consulting, helps individuals approaching or already in retirement explore strategies designed to protect their savings, pursue growth opportunities, and create dependable retirement income.
Whether you're considering a fixed indexed annuity or exploring other retirement strategies, we're here to help you make an informed decision.
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Sources: National Association of Insurance Commissioners, Buyer's Guide for Deferred Annuities. California Department of Insurance, Annuities: What Seniors Need to Know. California Life and Health Insurance Guarantee Association, Frequently asked questions. California Insurance Code section 10127.10. Internal Revenue Service, Publication 575.
