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Scroll down to learn more about fixed indexed annuities.
What is a fixed indexed annuity? How does it work?
A fixed indexed annuity, or FIA, is a retirement product that provides you guaranteed income during your retirement.
FIAs are sold by insurance companies. When you purchase an FIA, either in a single lump sum or in multiple payments over time, the insurance company invests that money, and credits interest to your annuity. Unlike a 401(k), however, the insurance company absorbs the risk of market downturns, guaranteeing that you will receive – at minimum – the principal amount you paid at purchase. In other words, the value of your money will never decline due to market loss for as long as it is in the FIA; but it does have the opportunity to increase, depending on the performance of the index it is linked to.
Annual returns in an FIA are calculated using a unique formula based on changes in the performance of stocks (S&P, Dow Jones, NASDAQ), bonds (Capital Markets Bond Index), or commodities (CBUE). While an index is used as an external benchmark to calculate returns, you do not actually invest your funds in one.
At the conclusion of the FIA contract, insurance companies can distribute returns to you in a single payment or a series of payments over time. In this way, FIAs are often referred to as providing a paycheck for retirees.
“An FIA is a retirement product that provides you guaranteed income during your retirement.”
“The value of your money will never decline due to market loss for as long as it is in the FIA; but it does have the opportunity to increase.”
What is the difference between FIAs and variable annuities?
FIAs guarantee a minimum fixed rate of return, regardless of market volatility, whereas the rate of return for variable annuities depends on the performance of the linked stock, bond, or money market investment. With FIAs, the insurance company assumes the risk, protecting the principal from market volatility for the annuity holder. With a variable annuity, this is not the case; the consumer assumes the risk.
“FIAs guarantee a fixed rate of return, regardless of market volatility…”
I have a strong 401(k) or similar account. Why would I need an annuity?
What are the benefits and downsides of FIAs?
The key benefit of an FIA is that it offers growth potential with principal protection from market loss. Unless you surrender your contract early, you cannot lose money. Your principal is guaranteed even if the linked index drops. Another benefit is that, as with a 401(k), any growth is tax-deferred.
It’s also worth noting that if withdrawn before retirement age or the full length of the contract, FIAs are subject to surrender charges. FIA returns are also often capped, meaning that there is a limit to how much the annuity holder can gain in a year, even when the index performs very well. But remember, even if the index goes down, the FIA doesn’t lose value.
“The key benefit of an FIA is it offers growth potential with principal protection from market loss. Unless you surrender your contract early, you cannot lose money.”
“Another benefit is that, as with a 401(k), any growth is tax-deferred.”
Is lifetime income really guaranteed?
“[Lifetime income is guaranteed] as long as you hold the annuity for the full term of the contract.”
Are FIAs safe to purchase?
FIAs are safe to purchase for anyone who is comfortable with the structure of the product. A risk to an FIA is if the insurance company becomes insolvent and cannot pay its claims, but in this highly unlikely scenario, state-run insurance guaranty associations could cover a portion of the annuity. Still, it is recommended that anyone interested in an FIA, or any insurance product, consider the financial strength rating and historical performance of the insurance company from which they intend to purchase.
Learn more about insurance credit ratings:
If my FIA balance grows one year, can I lose those gains the next?
“Once interest is credited to an annuity, it is locked, and is not subject to market volatility.”
Is an FIA right for me?
- have a retirement plan in place, but want to reduce the risk in your portfolio
- want a steady stream of retirement income during retirement
- want growth potential, coupled with principal protection from market loss
- seek a guaranteed minimum rate of return that never varies, regardless of market swings
- are very comfortable with risk and fluctuations in your portfolio balance
- have already incorporated into your portfolio other financial products that protect against market volatility
- anticipate you may need to cash in your annuity before the full term of the contract or before you reach retirement age
Some websites warn me against FIAs – why?
Not all annuities are created equally – and not all information about annuities is complete or factual. It is best to get your information from reputable sources. Always work with a licensed professional to review your financial needs to see if a FIA is right for you. FIAs are safe to purchase as long as you are comfortable with the structure of the product. Because market risk is absorbed by the insurance company, the only way to lose your principal balance is to withdraw the full amount of your annuity before the contract ends.
“FIAs from accredited insurance companies are safe to purchase as long as you are comfortable with the structure of the product.”
Can I make an early withdrawal if I need to?
Yes, you can make a partial withdrawal from your FIA as needed before the contract concludes. Most annuities have a penalty free withdrawal amount, although the exact percentage allowed varies based on the provider. Many annuities have various liquidity features. Be sure to understand these options before purchasing an annuity. While partial withdrawals within the allowed limits are not subject to surrender charges, the IRS may charge a 10% tax if these withdrawals occur before age 59 1/2. A full cash out from the FIA before the contract is complete, however, will result in a surrender charge from the insurance company as well as an IRS penalty.
NOTE: The Coronavirus Aid, Relief and Economic Security Act, or the CARES Act, waives the annual Required Minimum Distributions on certain tax-qualified annuities and retirement accounts for calendar year 2020 and may impact withdrawals for FIAs. Speak with your financial professional for the latest.
What happens when I die? Can my spouse continue to collect income?
What about inflation?
I read about performance caps. What does that mean?
FIAs typically include a cap on the amount an FIA will credit in a given year. In some other cases, FIAs do not have a cap, but in these instances, the insurance company may reduce the interest credited by a fixed percentage of the annual returns.
“FIAs typically include a cap on the percent of return the holder of the FIA may keep in a given year."
Should I purchase directly from an insurance company or go through a financial professional?
Here are some questions your financial professional should ask you:
If I want to learn more or purchase an FIA, where do I begin?
Individuals interested in learning more or purchasing an FIA should speak first to their financial professional.
