FIXED INDEXED ANNUITIES
What is a Fixed Indexed Annuity (FIA) ?
This is a question that will get you a variety of answers, depending on who you are asking (and sometimes their personal biases.) A fixed indexed annuity (FIA) is an annuity that uses a market index (like the S&P 500) to determine the interest rate that it pays on the contract. Because of this, FIA’s have the potential to earn more than fixed annuities.
A Fixed Index Annuity is a tax-favored accumulation product issued by an insurance company. It shares features with fixed deferred interest rate annuities; however, with an index annuity, the annual growth is bench-marked to a stock market index (e.g., Nasdaq, NYSE, S&P500) rather than an interest rate. An index annuity’s growth is subject to rate floors and caps, meaning it will not exceed or fall below the specified return levels even if the underlying stock indices fluctuate outside of those set parameters. In simplest terms, the insurance company bears the risk of a sharp stock market decline with this type of annuity. You cannot lose any of your principal with a fixed index annuity, and your potential gains are usually capped at a rate between 3% and 9%. Many fixed index annuities also offer premium bonuses, but usually at the expense of lower potential gains.
The way many FIA’s have been designed now, as insurance products, is to help protect your money in times of market downturn. This protection of your principal comes at a bit of a cost. In order to make sure that you do not lose your principal funds and the interest that you have already earned in your contract, the FIA limits what you may earn on the contract. You never earn full market gain. However, you never have to worry about any of the market loss. This means that if the market were to lose 2% over a year, your loss on your account would be $0. For example you had $100,000 in a contract originally, if the market climbs the following year and your contract gains 5%, you do not have to make up that lost 2% ($2000) from last year and end up with only $102,900. You would still have the full $100,000 at the start of the year, and then have the 5% gain and end up with $105,000. This is a simplified example of course.
In truth, the reason most people get an FIA is to make sure that the money they have is still there when they retire and to have it as guaranteed income. Often when the contract has finished its accumulation period, the funds are paid out as fixed monthly or yearly payouts. The annuitant can decide how they wish payouts to be made.
One advantage that a fixed index annuity has over a mutual fund or a bank Certificate of Deposit (CD) is that earnings grow on a tax-deferred basis. This means you pay no income taxes until you withdraw money from the annuity. This is especially important when you buy your index annuity with personal savings (so-called after-tax or “non-qualified” funds). Index annuities can also be purchased using rollover funds, funds transferred from a tax-qualified plan (i.e. IRA), or with a lump sum distribution from a 401k or pension plan. There is no tax advantage.
Fixed index annuities also offer a high degree of safety. Your premium and earnings are guaranteed by the issuing insurance company. Insurance companies are legally required to set aside assets (known as “reserves”) to cover potential claims made by their policyholders. Insurance companies are monitored by rating agencies such as A.M. Best, Standard and Poor’s, and Moody's. By reviewing the ratings an insurance company receives from these agencies, you may be able to determine if it is operating on a sound financial footing.
The first thing to note is that many FIAs offer a variety of strategy accounts you can choose from. The insurance company will credit your account with a rate tied to the performance of the particular strategy chosen.
Most FIAs are flexible premium annuities, meaning they accept multiple deposits over time. A single premium FIA contract would be one which only accepted a one-time initial premium.
When you purchase an FIA there is a “right to examine” or “free look” period (usually 10-30 days in most states) which gives you the right to return your policy for a full refund for any reason. Afterwards, you can cancel the contract at any time, although doing so will likely cause you to incur a surrender charge and also a market-value adjustment (a plus or minus “MVA”).