“Do fixed indexed annuities really offer the best of all worlds?”
As you approach retirement, protection of principal typically becomes more important than vying for significant growth (which oftentimes entails taking on more risk with your money). But depending on your financial strategy, you may have to â€śtradeoffâ€ť the opportunity for higher growth in order to keep from losing money in a downward moving stock market â€“ and this can result in lower retirement income, along with lost purchasing power in the future.
The good news is that there are ways that you could attain growth and protection, as well as a guaranteed income in retirement for as long as you may need it, regardless of what happens in the stock market, with interest rates, or even in the overall economy. And the solution is easier than you might think!
How to Ensure Growth, Protection, and a Reliable Income in Retirement
Many people set aside money â€śfor the future,â€ť in hopes of having a base to draw retirement income from. These funds may be held in a personal IRA (Individual Retirement Account), employer-sponsored retirement plan (such as a 401k), and/or personal savings and investments.
But even if youâ€™ve been a good saver for many years, there is no guarantee that youâ€™ll be able to generate an ongoing, reliable stream of cash flow down the road. Plus, a significant portion of your savings could be wiped out in the event of a market downturn.
And that could change everything.
As you get closer to retirement, risk is a key consideration, primarily because investment losses can lead to a smaller â€śbaseâ€ť from which to draw income. Plus, the larger the loss, the more the portfolio has to generate in the future just to get back to even.
The Bigger the Loss, the More It Takes to Get Back to Even
|Loss:||Gain needed to get back to even:|
On the other hand, until recently, interest rates on â€śsafeâ€ť investments like CDs (certificates of deposit) and bonds have been painfully low. So, for instance, a 2% return on a $1 million dollar portfolio would only generate $20,000 per year. Is that enough for you to live on for the rest of your life?
So, the key for many who are heading towards retirement is finding an opportunity for a higher rate of return, along with protection of principal before retirement â€“ and then a regular income stream when it is needed.
This is where the fixed indexed annuity can help.
What are Fixed Indexed Annuities and How Do They Work?
Fixed indexed annuities are a type of fixed annuity, but they have a bit more to offer. For instance, these flexible financial vehicles provide the opportunity for upside market-linked growth, while at the same time keeping principal protected from market downturns during the â€śaccumulationâ€ť period.
The growth that takes place in the fixed indexed annuity is tax-deferred. This means that there is no tax due on the gains unless or until they are withdrawn. Because of this, growth can accelerate quickly, as gains are being generated on your contributions, as well as on any previous growth, and on the funds that would have otherwise been paid in taxes.
Tax-Deferred versus Fully Taxable Investment Returns
One of the primary differences between the fixed and the fixed indexed annuity is the way that the return is calculated with the latter. For example, while regular fixed annuities pay fixed return that is set by the insurance company, fixed indexed annuities track the performance of an underlying market index, such as the S&P 500 or the DJIA (Dow Jones Industrial Average).
When the performance of the tracked index is positive in a given contract period (such as a year), a fixed indexed annuity is credited with a positive return â€“ usually up to a certain maximum, or cap.
But, in contract years where the underlying index performs poorly, the annuity is not credited with a negative return. Rather, fixed indexed annuities will typically have a guaranteed minimum â€śfloorâ€ť (which currently ranges between 0% to 2% on many fixed indexed annuities), which in turn, can keep principal safe in any type of market environment.
Unlike investments in the stock market, when a fixed indexed annuityâ€™s underlying index performs in the positive again, there are no prior losses to make up for. So, the return going forward can build upon the previous gains â€“ which are locked in, never to be lost.
The method for determining your return on a fixed indexed annuity can also depend on the features of the specific annuity that you have. Typically, though, you can generally choose one or more market indexes that the value of the annuity will be allocated to.
There may also be various crediting methods to choose from for tracking the changes in the underlying market index(es). Several of the factors that are involved with tracking these changes can include a(n):
1. Cap â€“ A â€ścapâ€ť is a pre-set maximum on how much your annuity can earn in a given time period. For example, if the underlying index that your annuity is tracking has a return of 7%, and the annuity has a cap of 4%, your account will be credited with the 4%.
(Keep in mind, however, that if the underlying index falls in a given time period, the annuity will not incur a loss. So, if keeping principal safe is a primary goal of yours, this â€śtradeoffâ€ť can be well worth it).
2. Participation Rate â€“ A participation rate on a fixed indexed annuity determines how much of the underlying indexâ€™s return will be used in computing the indexed return. For instance, if the participation rate on the annuity is 80%, and the underlying index returns 10% for a given period of time, the annuity will be credited with 8% for that period. (This is because 80% of 10% is 8%)
Itâ€™s important to note that an indexed annuity could have both a cap and a participation rate. So, all of these elements need to be considered in determining the annuityâ€™s overall return.
3. Spread â€“ On some fixed indexed annuities, the return will be based on subtracting a certain percentage from any gain that the underlying index attains in a given time period. This is known as the spread.
As an example, if the annuity has a spread of 5%, and the underlying index increases by 9%, the annuityâ€™s return for that time frame would be 4%. (9% minus 5% = 4%)
In addition to the opportunity for higher returns without added risk, fixed indexed annuities can also offer a steady and reliable income stream, either for a pre-set time period (such as 10 or 20 years) or even for the remainder of the recipientâ€™s lifetime, no matter how long that may be.
Joint Life Income Option
Many fixed indexed annuities will also offer a joint life income option where it will continue to pay out for the remainder of two individualsâ€™ lives. This option is often chosen by partners or married couples who want to ensure that neither will run out of income in retirement.
Upon the death of the first individual, the dollar amount of the income payment may be reduced, or alternatively, it could remain the same, depending on the particular annuity.
Options for Customizing a Fixed Indexed Annuity
In addition to growth, tax-deferral, principal protection, and lifetime income generation, there are some other benefits that may also be offered on a fixed indexed annuity, such as a(n):
- Death benefit
- Penalty-free terminal and/or chronic illness waiver(s)
- Long-term care waiver
Fixed indexed annuities typically allow the contract owner to designate one or more beneficiaries to receive a death benefit upon the ownerâ€™s death. Because these funds are paid out directly to the beneficiary(ies), it can help with avoiding the time and expense of having to go through probate.
A â€śstepped upâ€ť death benefit might also be an option on some annuities, whereby the amount of the proceeds is more than the amount of the annuityâ€™s remaining contract value.
Some fixed indexed annuities will also allow for penalty-free withdrawals if the owner or annuitant (i.e., the income recipient) is diagnosed with a terminal or chronic illness and/or if they must reside in a nursing home for a certain period of time. (Usually, this time period is 90 days or longer).
In addition, even with all of the â€śstandardâ€ť features that are found on fixed indexed annuities, these financial vehicles can typically be â€ścustomizedâ€ť even further using riders. Adding these enhancements can help you to better meet your specific short- and long-term objectives.
For example, income riders on fixed indexed annuities are contract benefits that are designed for guaranteeing a certain rate of growth that is represented as a percentage. This can help with planning for your income needs in retirement.
The Pros and Cons of Fixed Indexed Annuities
Fixed indexed annuities can offer a number of unique advantages, both before and after you retire. Because of that, some investors and financial professionals state that these financial vehicles provide a â€śbest of all worldsâ€ť scenario when it comes to growth, protection, and retirement income.
There are several advantages that can come with owning a fixed indexed annuity, such as:
- Opportunity for a market-linked return
- Principal protection (in any type of market or economic environment)
- No or low fees
- Tax-deferred growth / option to add to tax-advantaged savings
- No required minimum distributions (RMDs)
- Some liquidity (even during the surrender charge period)
- Flexible contribution options
- Death benefit (and the ability to leave a legacy)
- The ability to â€ścustomizeâ€ť the annuity with additional riders
- Protection from creditors and bankruptcy (in some states)
- Lifetime income in retirement
Even with all of the enticing features that fixed indexed annuities can offer, though, there are some items that you should consider before making a long-term commitment to purchasing one.
Items you should consider include the following:
- Limited liquidity in the early years (i.e., surrender period)
- Upside Limitations (due to caps, participation rates, and/or spreads)
- No or limited inflation protection on the income payout (on many fixed indexed annuities)
- May have a minimum contribution requirement
- Can be confusing due to many â€śmoving partsâ€ť
Because not all fixed indexed annuities are the same, it is important that you have a good understanding of these financial vehicles before you contribute a significant amount of money to one. Talking with a retirement income specialist can help you to narrow down the best option for you and your specific needs and objectives.
The Pros and Cons of Fixed Indexed Annuities
|Fixed Indexed Annuity Advantages||Fixed Indexed Annuity Drawbacks|
|Opportunity for market-linked return||Limited liquidity in the early years (i.e., surrender period)|
|Principal protection in any type of market or economic environment||Limit on the upside protection (due to caps, participation rates, and/or spreads)|
|No / low fees||No or limited inflation protection on the income payout|
|Tax-deferred growth / option to add to tax-advantaged savings||May have a minimum contribution requirement|
|No required minimum distributions (RMDs)||Can be confusing due to many â€śmoving partsâ€ť|
|Some liquidity (even during the surrender charge period)|
|Flexible contribution options|
|Death benefit (and the ability to leave a legacy)|
|The ability to â€ścustomizeâ€ť the annuity with additional riders|
|Protection from creditors and bankruptcy (in some states)|
|Lifetime income in retirement|
How Fixed Indexed Annuities Compare to Other Annuity Types
The structure of the fixed indexed annuity provides steady income payments and the ability to diversify a portfolio â€“ which can help you to reduce the impact of equity market downturns. It also gives investors and retirees another possible avenue for improving their portfolioâ€™s up/down capture, with the protection of principal and the opportunity for tax-deferred growth.
Although these financial vehicles can offer a long list of enticing features, though, it is important to know the difference between fixed indexed annuities and other annuity types so that you can make the best decision possible regarding your retirement savings and future income.
The two other primary types of annuities include:
- Fixed Annuities
- Variable Annuities
Fixed annuities provide a specified rate of interest that is set by the offering insurance company. These annuities can also offer a known amount of income on a regular basis, when (or if) the annuity is converted over into an income stream.
With these types of annuities, you can keep principal safe in any type of market environment. Because of that, fixed indexed annuities are often used by investors who are risk averse, as well as those who are approaching retirement and want to ensure that their principal is not at risk of loss.
In addition to their set rate of return and safety of principal, fixed annuities may also offer some added features, such as a death benefit, and/or penalty-free withdrawals if the owner is diagnosed with a terminal illness and/or is in need of long-term care services.
As with fixed indexed annuities, a regular fixed annuity can be either immediate or deferred. With an immediate fixed annuity, a lump sum contribution is typically made, and then income begins right away (or within 12 months of purchasing the annuity).
Deferred fixed annuities have two different â€śphases.â€ť These include the accumulation phase and the distribution, or income, phase.
During the accumulation phase, contributions can be made (either with just one single deposit, or through multiple contributions over time). The funds that are inside of the annuity are allowed to grow on a tax deferred basis, so no tax is due on this gain until the time of withdrawal.
Fixed (and fixed indexed) annuities may also be either qualified or non-qualified. For instance, if the annuity is funded with pre-tax money (such as through an employer-sponsored retirement plan or traditional IRA account), it is considered to be qualified. In this case, 100% of the money that is withdrawn will be taxable at your then-current income tax rate. This is because none of the contributions, nor the gains, have yet been taxed.
Alternatively, a non-qualified annuity is funded with after-tax dollars. (The gain in a non-qualified annuity will still grow on a tax-deferred basis, though). Therefore, only a portion of the income or withdrawals from a non-qualified annuity will be taxable. This is determined through the exclusion ratio, which refers to the percentage of an investorâ€™s return that is not subject to taxes.
In the case of a non-qualified annuity, then, the portion of a withdrawal or income payment that is considered to be a return of principal is not taxed, and the portion that is considered gain will be taxed at your then-current ordinary income tax rate.
Pros and Cons of Regular Fixed Annuities
|Fixed Annuity Advantages||Fixed Annuity Disadvantages|
|Set rate of return||Low return|
|Protection of principal||Surrender charges|
|Tax-deferred growth||Limited liquidity|
|Guaranteed lifetime income|
|Penalty-free access to funds for health or long-term care needs*|
*Note that not all features are available on all fixed annuities
Like other types of annuities, a variable annuity is a contract between an individual and an insurance company. Through this contract, the insurance company agrees to make periodic payments to the annuitant (i.e., the income recipient). These payments may begin right away, or alternatively, they may start at a time in the future.
Variable annuities offer investors a way to participate in market appreciation by tracking underlying equity investments like mutual funds. In many cases, this can offer the opportunity for unlimited growth.
However, the funds that are inside of a variable annuity are not directly invested in the market, but rather they are held in â€śsub-accountsâ€ť at the insurance company. If these investments perform well in a given contract year, a positive return is credited to the variable annuity. However, if they perform poorly, there is the risk of loss. With a variable annuity, it is possible to lose previous gains, as well as your original contribution(s).
Oftentimes, variable annuities will also offer a fixed account that pays a set rate of interest. While the insurance company is allowed to reset this fixed interest rate, there is usually a guaranteed minimum that is stated in the annuityâ€™s contract.
Variable annuities are considered securities. So, these financial vehicles are regulated by the Securities and Exchange Commission (SEC). Therefore, prior to purchasing a variable annuity, you must receive a prospectus.
Unlike fixed and fixed indexed annuities, variable annuities are known for charging high fees, which in turn, could have a negative impact on your overall return. In some cases, the total fees on a variable annuity could be between 1% and 3%.
Some of the most common fees that are associated with variable annuities include the following:
1. Mortality and Expense (M&E) fees â€“ Mortality and expense fees generally cover items like the annuity payout / guaranteed income feature, as well as the annuityâ€™s guaranteed death benefit.
2. Administrative fees – Administrative fees are typically charged on an annual basis. These cover record keeping, as well as various other administrative expenses.
3. Investment management fees – The investment management fees relate to the underlying mutual funds and/or other investments that are being tracked by the variable annuity. These fees are typically charged by each of the individual investments.
3. Rider charge(s) – If additional features, or riders, are added to the annuity, there may also be an added expense for these.
4. Surrender / early withdrawal charges – Most annuities include surrender charges. If you withdraw more than a certain amount from the annuity contract within the first several years â€“ or if you cancel the annuity contract altogether â€“ you will incur a surrender charge.
Typically, the amount of the surrender charge will decrease over time, until it disappears altogether. In addition, you may owe tax on your withdrawals. And, if you make such withdrawals before you are age 59 Â˝, an additional 10% â€śearly withdrawalâ€ť penalty may be levied by the IRS. Therefore, you should only contribute money to an annuity that will not be needed for emergencies or other near-term financial obligations.
Pros and Cons of Variable Annuities
|Variable Annuity Advantages||Variable Annuity Drawbacks|
|Opportunity for market-linked growth||Risk of loss / poor performance of the underlying investment(s)|
|Tax-deferred gains||Charges and fees â€“ including surrender / early withdrawal penalties|
|Death benefit||Limited liquidity|
Fixed, Fixed Indexed, and Variable Annuity Comparison
Because not all annuities are alike, there are some investors and retirees that may benefit from one type of annuity and not another, and vice versa. Therefore, it can help to review a side-by-side comparison of fixed, fixed indexed, and variable annuities. This can guide you with narrowing down which type of annuity â€“ if any â€“ is best for you.
Comparing Fixed, Fixed Indexed, and Variable Annuities
|Fixed Annuities||Fixed Indexed Annuities||Variable Annuities|
|Contribution(s)||Single or multiple||Single or multiple||Single or multiple|
|How return is calculated||Rate set by the insurance company||Underlying market index(es) are tracked||Performance of one or more investments (such as mutual funds)|
|Growth||Tax deferred||Tax deferred||Tax deferred|
|Protection of principal||Yes||Yes||No|
|Risk of market losses||No||No||Yes|
|Charges / fees||Low or no||Low or no||High|
The Best Insurance Companies for Fixed Indexed Annuities
There are many insurance carriers that offer fixed indexed annuities. But not all of these insurers have the same products available. They may also differ in terms of financial strength and stability, as well as in their reputation for paying out their policy holdersâ€™ claims.
With that in mind, it is essential that you review the annuity product, as well as the offering insurance company, before you move forward with purchasing an annuity.
Some of the top companies that offer fixed indexed annuities are:
- Lincoln Financial Group
- North American (North American Company for Life and Health Insurance)
Lincoln Financial Group
Lincoln Financial Group has been in insurance and financial services business for over a century. The companyâ€™s primary focus is to provide consumers with peace of mind by helping them to plan, protect assets, and retire with confidence.
Today, Lincoln Financial Group has approximately 16 million customers. It has a strong financial foundation and in turn, high financial strength and stability ratings from the insurer rating agencies, including a(n):
- A+ from A.M. Best
- A+ from Fitch
- A1 from Moodyâ€™s
- AA- from Standard and Poorâ€™s
The fixed and fixed indexed annuities that are offered through Lincoln Financial can provide reliable lifetime income in any type of market or economic environment. There are several fixed indexed annuity options to choose from with Lincoln Financial Group. These include the:
- Lincoln OptiBlend Fixed Indexed Annuity
- Lincoln Covered Choice 5 Fixed Indexed Annuity
- Lincoln Covered Choice 5 ll Fixed Indexed Annuity
- Lincoln Covered Choice Advisory 5 ll Fixed Indexed Annuity
- Lincoln FlexAdvantage Fixed Indexed Annuity
North American Company for Life and Health Insurance
North American Company for Life and Health Insurance (or simply, North American) has also been in the business of protecting their clientsâ€™ wealth â€“ and retirement income generation â€“ for more than a century. Today, North American is part of the Sammons Financial Group, a holding company whose member companies offer financial services and retirement products.
Throughout the years, North American has served more than 1 million customers â€“ and as of year-end 2021, the company had in excess of 215,000 annuity policies in force. Also considered strong and stable financially, North American Company for Life and Health Insurance has high ratings, which include a(n):
- A+ from A.M. Best
- A+ from S&P Global Ratings
- A+ from Fitch Ratings
In addition, North American has earned a grade of A+ from the Better Business Bureau. The company offers a variety of annuity options, including fixed indexed annuities, multi-year guarantee annuities (MYGAs), and single premium immediate annuities (SPIAs).
Is a Fixed Indexed Annuity Right for You?
Many investors, retirees, and financial professionals believe that fixed indexed annuities offer a win-win-win scenario, given that they provide the opportunity for growth, protection of principal, and an ongoing income stream in retirement that you can rely upon â€“ possibly even for the remainder of your lifetime.
Because of this, you can reduce the stress that comes with losing money in a stock market correction, while at the same time feel assured that the dollar amount of your retirement income that is generated from a fixed indexed annuity wonâ€™t change, based on interest rate reductions in the economy.
While not everyone is a good candidate for a fixed index annuity, this particular financial vehicle could be a viable option if you are seeking one or more of the following:
- Index-linked growth
- Tax deferred gains
- Safety of principal
- Access to funds if needed (usually up to 10% of the contract value during the surrender period)
- The ability to leave a legacy
- A lifetime stream of income that you can count on for the remainder of your (and possibly also your spouse or partnerâ€™s) lifetime â€“ regardless of how long you may need it
How to Match a Fixed Indexed Annuity with Your Unique Goals and Needs
The ideal retirement can differ â€“ sometimes substantially â€“ from one person to another. Everyone also has different time frames and levels of risk that theyâ€™re comfortable taking with their money. Thatâ€™s why there is no such thing as a one-size-fits-all investment or insurance product that works for all.
Given that, before you make a long-term financial commitment to purchase a fixed indexed annuity, it is recommended that you first understand how and why this type of financial vehicle may (or may not) fit into your overall portfolio.
Working with a retirement income specialist can help. At Insurance and Estates, we specialize in helping our clients protect the people they love. This includes ensuring that you have income for life â€“ regardless of market or economic conditions â€“ so that you can focus on the more important things in life.
If you would like to learn more about fixed indexed annuities in order to determine whether or not this financial vehicle would be a good fit for your needs, feel free to contact us directly by calling (877) 787-7558 or you can simply click the button below to request an fixed index annuity expert give you a call at your earliest convenience.