A fixed index annuity is a type of fixed annuity so your money is not directly invested in the market and is protected from any potential market. An indexed annuity credits interest based on the performance of a market index rather than guarantee an interest rate like traditional fixed annuities.
Shopping for a fixed index annuity may seem overwhelming but it doesn’t have to. In this index annuity guide you’ll learn:
This historic volatility combined with the limited availability of traditional retirement income sources, such as defined benefit pension plans, has placed a greater responsibility on Americans saving for their future.
With this greater responsibility comes a need for financial solutions that can help provide a new level of protection for retirement savings. Whether your long-term objective is to build a source of guaranteed lifetime income, save for a specific retirement goal, or leave a legacy for your loved ones, an fixed index annuity is designed to help you meet your retirement income goals.
A fixed index annuity is a contract between you and an insurance company that may help you reach your long-term financial goals. In exchange for your premium payment, the insurance company provides you income, either starting immediately or at some time in the future.
NOTE: You may also hear of a fixed index annuity referred to as a:
Most fixed index annuities have two phases. First, there’s an accumulation phase, during which you let your money earn interest. This is followed by a distribution or payout phase, during which you receive money from your annuity.
A fixed index annuity also guarantees you will receive at least the minimum guaranteed interest credited to the contract. Remember that all of these guarantees are backed by the claims-paying ability of the issuing company.
With a fixed index annuity, you defer paying taxes on your contract’s interest until you receive money from the contract. Tax-deferred interest means the money in your contract can grow faster.
Your principal and bonus are never subject to market index risk. A downturn in market index(es) cannot reduce your contract values.
This is the company that issues the annuity. The insurance company is responsible for backing the annuity’s guarantees.
These usually are the same person, but they can be different. The owner makes decisions about the annuity, such as who the beneficiaries are. The annuitant is the person whose life expectancy is used to calculate annuity payments.
The beneficiary is the person who receives the annuity’s death benefit. Naming one or more beneficiaries other than the estate is important because, without a beneficiary, the money in your annuity could be
subject to probate.
Fixed index annuities have three main benefits; tax deferral, indexed interest potential, and principal protection.
Under current federal income tax law, any interest earned in your fixed index annuity contract is tax deferred. You don’t have to pay ordinary income taxes on any taxable portion until you begin receiving money from your contract. Withdrawals are taxed as ordinary income and, if taken prior to age 59½, a 10% federal additional tax may apply.
Fixed index annuities provide an opportunity for potential interest growth based on changes in one or more indexes. Because of this potential indexed interest, FIAs provide a unique opportunity for accumulation. And since the interest your contract earns is tax-deferred, it may accumulate assets faster. In addition to potential indexed interest, FIAs can offer you an option to receive fixed interest.
Fixed index annuities offer you a level of protection you may find reassuring. That protection can benefit you in three separate ways:
• Accumulation: Your principal and credited interest are protected against market downturns.
• Guaranteed income: You can be protected from the possibility of outliving your assets.
• Death benefit: If you pass away before annuity payments begin, a fixed index annuity may help you provide for your loved ones.
During the accumulation phase of your contract, any interest credited is tax-deferred. If you purchase your fixed index annuity with after-tax dollars, you will only pay ordinary income taxes on your earnings – not on your premium payments – when you begin withdrawing money.
Tax-deferred growth, compounded over time, may increase the amount of savings and income your fixed index annuity generates for your retirement.
Tax deferral is also a benefit of traditional IRAs and 401(k)s. However, annuities don’t have any government-imposed contribution limits. Because of that, they can often be a good choice if you want to save more than IRAs and 401(k)s allow and still enjoy tax-deferred growth potential.
Purchasing an annuity within a retirement plan that already provides tax deferral results in no additional tax benefit. So use an annuity to fund a qualified plan based upon features other than tax deferral, such as lifetime income options or the guaranteed death benefit.
Tax deferral can be an effective part of your retirement strategy. For example, this chart shows how a $100,000 initial payment, compounded at 4% annually, grows tax-deferred. Twenty years later, after taxes are paid on the lump-sum distribution, the amount is greater than the amount accumulated in a taxable product after 20 years.
Assumes a 33% ordinary income tax assessed yearly on taxable earnings and at period end on tax-deferred earnings. Actual tax rates may vary from this example for different taxpayers and assets (e.g., capital gains and qualified dividend income). Actual performance of your contract will also vary.
Hypothetical interest is not guaranteed and does not represent the performance of any particular annuity. If a withdrawal or distribution is taken, the tax-deferred earnings would be reduced by income taxes on any interest and, if taken prior to age 59½, a 10% federal additional tax may apply.
Consider your personal retirement plan and income tax brackets, both current and anticipated, when making financial decisions.
Investors who own annuities, across all wealth segments, are more confident that their savings and investments won’t run out, even if they live into their 90s.¹
Another advantage of a fixed index annuity is the opportunity to accumulate interest based on changes in an external index. Some FIAs offer you a choice of indexes rather than just one. In addition to choosing your indexes, you can also determine what portion of your annuity’s value will be based on each index chosen.
Although an external market index or indexes may affect your contract values, the contract does not directly participate in any stock or equity or bond investments. You are not buying shares of any stock or index fund.
When you purchase a fixed index annuity, you can allocate its value to one or more chosen indexes. We then use a crediting method (which we will define later) to track the performance of your index(es). At the end of each crediting period, we calculate the indexed interest.
If the result is positive, you will automatically receive indexed interest, subject to a participation rate and a cap or spread (which we will also define later). That interest is locked in at the end of each crediting period and cannot be lost due to index declines at some point in the future.
If the result is negative, nothing happens – and that can be good news! Although you won’t receive any indexed interest for the crediting period, your annuity’s value doesn’t decline.
When you purchase your fixed index annuity, you can often choose the index (or indexes) to which you allocate your annuity’s value. Before we discuss those crediting method choices, let’s look at some other factors that will affect how your indexed interest is calculated.
Cap. Some fixed index annuities set a maximum rate of interest (or cap) that the contract can earn in a specified period (usually a month or year). If the chosen index increase exceeds the cap, the cap is used to calculate your interest.
For example, if the annual cap in a hypothetical example were 3.00% and the value of the index rose by 4.80%, the cap amount of 3.00% would be credited to your contract. However. if the index change was 2%, your contract would be credited 2% since that is lower than our hypothetical cap.
Participation rate. In some annuities, a participation rate determines what percentage of the index increase will be used to calculate your indexed interest.
For example, let’s suppose the index rose by 10%. If a hypothetical FIA had a 75% participation rate, the contract would receive 7.5% in indexed interest. (Participation rates are generally applied after caps, and before a spread.)
Spread. The indexed interest for some annuities is determined by subtracting a percentage from any gain the index achieves in a specified period. For example, if the annuity has a 4% spread and the index increases 10%, the contract is credited 6% indexed interest.
No single index annuity crediting method consistently delivers the most interest under all market conditions. A quick definition of some popular crediting method choices is provided below. For a better understanding of how each crediting method works, talk to your financial professional. Keep in mind that caps, participation rates, and spreads will also enter the calculation of indexed interest and may reduce the amount of interest credited.
This method tracks changes in the market index from one crediting period to the next and credits interest based on that change.
With this method, individual monthly increases and decreases in the index values are tracked and added up. Their sum helps determine the indexed interest credited to the annuity.
Annual reset is a common FIA feature that automatically resets your annuity’s index values at the end of each contract year. That means this year’s ending value becomes the next year’s starting value – locking in any interest your contract earned during the year and ensuring you do not need to make up losses in the index before you see any additional credits in the future.
Annual reset is typically available on monthly sum and annual point-to-point crediting methods.
Multi-year reset is an FIA feature that automatically resets your annuity’s index values at the end of a longer crediting period, such as 2-year point-to-point. Similar to annual reset, that means the crediting periods’ ending value becomes the next crediting periods’ starting value – locking in any interest your contract earned and ensuring you do not need to make up losses in the index value before you see additional credits in the future.
A point-to-point strategy compares index values from two points in time: the closing value at the end of a term to the closing value on the first day of a term. If the result is positive, interest is credited, subject to the cap, spread or participation rate. If the result is negative, the credited interest rate is 0%.
The below table shows a hypothetical index value change from 100,000 on contract issue to 107,000 at contract anniversary. This represents an annual index performance of 7%.
Take the index change of 7% and apply the cap, spread or participation rate. For this example we will assume a 5% cap, 2% spread and a 75% participation rate.
5% Cap = 5% Interest credited (index change up to the cap)
2% Spread = 5% Interest credited (index change – spread)
75% Participation Rate = 5.25% Interest Credited (index change X spread)
A third important advantage of a fixed index annuity is the range of guarantees and optional income benefits available. These benefits allow you to transfer risk to the insurance company issuing the fixed index annuity. These guarantees help protect your assets, your retirement income, and your beneficiaries. In exchange for the risk transfer, the benefits may carry an additional cost that will vary by product and company.
Annuities are subject to surrender charge periods, which can vary, but are generally between five and 10 years in duration. If you abide by the term of your contract, you will not lose any of the money you place in your annuity due to surrender charges or MVAs. Additionally, any interest credited to the contract is locked in and protected as well.
An MVA is a calculation used to adjust the contract values according to corporate bond yields at the time the withdrawal is taken. The MVA may increase or decrease the contract’s cash surrender value. The MVA can never cause the cash surrender value to be less than the guaranteed minimum value or greater than the accumulation value.
A fixed index annuity puts you in control of your future income, based on the annuity you choose and how much money you put into it.
After your contract has had an opportunity to earn interest over its accumulation period, you can begin distribution. You can then receive your contract’s values in a stream of income that will last your lifetime (or longer). The amount of your payments is based on the value of the contract on the date you begin distribution and the payout schedule you choose.
You generally have two choices for receiving income payments: annuitization payments or income withdrawals. For annuities that are not held in a qualified plan such as an IRA or a 401(k), part of each annuitization payment is a tax-free return of what you paid for the annuity and part is taxable as interest you earned on the annuity.
On the other hand, income withdrawals under the same annuity are fully taxable until the interest you earned has been withdrawn. Then you withdraw what you paid for the annuity tax-free. It’s always a good idea to consult with your tax advisor before choosing between annuitization payments and income withdrawals.
As we noted, an FIA allows you to convert your annuity’s value into a series of fixed-amount payments. Depending on the product you choose, many FIAs go beyond this. They offer benefits or optional income riders with payments that can increase to assist with inflation throughout retirement.
Your income payments will be scheduled as withdrawals you can begin any time after you reach a certain age (often age 60). And with some FIAs, your income payments will be larger if you postpone taking them for a few years.
These income riders or benefits provide valuable advantages, but they usually come at a cost. Your financial professional can discuss the income costs, and restrictions offered by the FIA you are considering. Please note that withdrawals may be subject to regular income tax and, if taken prior to age 59½, a 10% federal additional tax may apply.
If you die before you begin to receive scheduled annuity payouts of the contract’s value, your beneficiary will receive a death benefit. And in some cases, even if you die after you have begun to receive income from the annuity, it’s still possible your beneficiary will receive a death benefit.
Your beneficiary may choose to receive your contract’s values in a single payment or in a series of payments over time.
The death benefit may be a reason some individuals purchase annuities even though they have no immediate plans to receive their contract values. They simply want to know the money is available (may be subject to a surrender charge) should they need it – and that it can be passed on to their beneficiaries if they don’t use it.
Yes. Insurance companies as a whole have a long history of stability, even through our nation’s most difficult economic times. Fixed index annuities, unlike variable annuities, are backed by the full faith and credit of the issuing insurance company.
Fixed index annuities are a type of fixed annuity that earns interest based on changes in a market index, which measures how the market or part of the market performs. The interest rate is guaranteed to never be less than zero, even if the market goes down. The return earned in a variable annuity isn’t guaranteed.
Fixed Index Annuities are a type of fixed annuity that offers a change to earn more when the markets perform and downside protection from potential market downturns.
In the broadest terms, an annuity is a contract between you and an insurance company, where you make a premium payment(s) in exchange for the benefits defined in the contract.
Source: LIMRA Secure Retirement Institute U.S. Individual Annuity Sales Survey
The opportunity to grow value and lock in gains without the risk of the stock market or individual stocks is the biggest Pro of Fixed Indexed Annuities. You don’t get all of the market upside, but in exchange, your account will never loose value due to market performance.
To be fair when sorting out fixed index annuity pros and cons, it is important to remember that a fixed index annuity is a retirement savings vehicle and not an investment. As such, they should not be compared to or expected to perform like an equity.
Fixed index annuities provide more upside potential than any other product offering principal protection. For many of our clients that own indexed annuities, upside potential and downside protection was a main objective.
Below is a hypothetical example of an index annuity purchased on 12/31/2006, with a 5% annual S&P cap. I believe the chart does a good job of illustrating two other important Fixed Index Annuity Pros: “lock-in” and “annual reset” features.
Can be turned into guaranteed lifetime income you cannot outlive
A question we often hear is, “What is the difference between a variable annuity and a fixed index annuity?” The are many differences but probably the biggest is variable annuities can lose value due to market performance.
When you purchase a variable annuity, you invest directly in sub accounts; like how you select different funds inside of your 401(k). This means you’re account value will go up or down based on the performance of your selected funds.
Variable annuities usually come have multiple fees while indexed annuities do not have a fee unless an optional rider is attached.
Variable Annuity Fees
If you are considering purchasing a variable annuity you will find the U.S. Securities and Exchange Commission’s (SEC) Variable Annuities: What You Should Know investor tips.
Fixed indexed annuities rates of return are calculated annually and are based on the performance of a market index. However, you are not directly invested in the market which has its pros and cons.
Your account value will never decrease due to market performance, but you do not typically earn all the upside either. Your interest is calculated and credited annually based on the performance of the market index and crediting method you’ve selected.
Access up to 10% of your annuity account value without a surrender charge.
Withdraw you accumulated interest without surrender penalty. May be taken systematically; monthly, quarterly, semi-annually or annually.
If you are confined to a nursing-home or long-term care facility for at least 90 consecutive days (after the first contract year), this waiver provides you with the option to withdraw 100% of your account value without incurring an early withdrawal penalty.
After the first contract year, if you are diagnosed by a physician as having a terminal illness, you have the option to withdraw up to 100% of the account value without incurring an early withdrawal charge. A terminal illness is defined as having a prognosis of survival of 12 months or less, or a longer period as required by state law.
Our Annuity Terms Glossary has a more comprehensive list of annuity term definitions written in plain English.
Annuities are distributed by My Annuity Store, Inc. Guarantees are subject to the claims-paying ability of the insurer. My Annuity Store, Inc. does not advise clients on the purchase of non-fixed annuity products. The information presented here is not intended to be a recommendation to purchase a fixed annuity (MYGA), fixed index annuity(FIA), variable annuity (VA), registered index linked annuity (RILA), immediate annuity (SPIA), longevity annuity, or Qualified Longevity Annuity Contract (QLAC).
The contract features described may not be current and may not apply in the state in which you reside. Insurance companies often issue contracts which are ‘state-specific’. Insurance companies also change their products and information often and without notice. Annuities are subject to the terms and conditions of the specific contract issued by the insurer, are not FDIC or NCUA insured, are not bank guaranteed, may lose value, and are not a deposit. Please call (855) 583-1104 if you have any questions or concerns.
The information presented here is not a representation regarding the suitability of any concept or product(s) for an individual and it does not provide tax or legal advice. You should always consult your own financial planning, tax, and legal advisors to determine if a fixed annuity, fixed index annuity, annuity with long term care rider, immediate annuity, longevity annuity, or Qualified Longevity Annuity Contract are suitable in your financial situation.
23 page research paper written by Nobel Prize winning Economist, Roger Ibbotson, systematically compares bonds vs. annuities. By downloading you agree to receive our bi-weekly newsletter and annuity rate updates.