When economic and market conditions seem uncertain, it’s natural for people to look for places to protect their money from losses. Some places are pretty low risk and let your money earn interest. You can find many of these options at banks: certificates of deposit, savings accounts, money market accounts, and high-yield savings and checking accounts, to name a few.
If you are looking to park retirement money somewhere, a fixed index annuity may also be an option to explore. A fixed index annuity shields your money from losses due to market declines. It gives limited opportunity to earn interest based on a market index’s performance. That being said, in exchange for the guaranteed protection of your money, that growth potential is limited.
Bank products will grow your money with interest over time, and they are backed by FDIC coverage. You can also use bank accounts as a source of liquidity for your money. But over time, a fixed index annuity can let you “beat the bank” with its potential for index-linked interest earnings. If you plan to use that money for retirement, the annuity can also pay you a guaranteed income stream for as long as you need it.
In this article, we will go over more on fixed index annuities, their potential for “beating the bank,” and some pros and cons for each option that are good to keep in mind.
How Do Fixed Index Annuities Work?
Just like with other types of annuities, a fixed index annuity is an insurance product. It’s a contract between the annuity owner and the life insurance company that issued the annuity.
In exchange for the annuity owner’s money, the insurance company makes contractual promises, such as guaranteeing an income the owner can’t outlive. In our case here, a fixed index annuity is also rich with other guarantees: guaranteed protection of your principal, minimum guarantees relating to the annuity’s growth potential, and more.
How could this annuity grow in value? A fixed index annuity has an underlying benchmark index, such as the S&P 500 price index. When the index goes up in value, your money in the annuity can earn interest, which is based on a portion of the gain. When the index goes down in value, your money earns zero percent. The current value of your money is locked in, and your money is protected from index losses.
The index performance is tracked and any interest credited over a certain timespan, such as one year. When the time period is passed, there is a “reset,” and the current value of the index is used as a new starting point.
In exchange for the protection against market losses, the growth potential of a fixed index annuity is limited by caps, participation rates, and spreads. It’s the trade-off for having that safeguard. You also don’t have as much liquidity in an annuity as you do with other financial products, and that is also a trade-off for the guaranteed benefits that you receive.
A Quick Rundown on Bank Products
Of course, we are talking about how a fixed index annuity gives you a chance to beat the bank. So, what about bank products? Bank products are typically insured by the FDIC, so that product owners are protected up to a certain amount.
Most people are familiar with a traditional savings account. It’s a bank account in which people can deposit money and earn interest on their savings. A savings account is intended as a low-risk place to keep your money. That being said, the interest rate is usually quite low. Savings account funds are very liquid, and the account may come with a minimum balance requirement so that you don’t pay any fees.
Money Market Accounts
A money market account is a kind of savings account offered by a bank. It combines the features of a traditional savings account and a checking account. Money market accounts typically offer higher interest rates than regular savings accounts.
They also provide relatively easy access to your money, but there may be limits on the number of monthly transactions you can make. Your money market account may also come with a check-writing ability, albeit to a fault. Again, the money market account is intended as a low-risk savings vehicle.
High Yield Checking and Savings Accounts
High-yield checking and savings accounts are like traditional checking and savings accounts, but they usually come with higher interest rates. With the high-yield savings account, you will usually have a minimum account balance to maintain in exchange for the higher interest rate. The minimum account balance requirement can be fairly high depending on your bank.
For the high-yield checking account, you have checking transactions. You may face requirements such as a certain amount of monthly debit card transactions, direct deposit, and online banking usage in order to qualify for the higher interest rate.
These accounts do offer liquidity, but typically not as much as traditional bank account products. That is a trade-off for the higher interest rate for your money.
A bank certificate of deposit is also known as a bank CD. It’s a low risk investment, in which someone agrees to keep a certain amount of money deposited over time, in exchange for a set interest rate. That span of time is called a maturity or term, and it can range from a few months to several years. Bank CDs generally pay more interest than regular savings accounts.
The liquidity in a bank CD is very limited. You also don’t have as much flexibility as you do with other bank products. The earnings on a bank CD are taxable as ordinary income (as are annuities, to be clear). Like with other bank products, CDs come with a minimum required deposit to be met.
How Do Fixed Index Annuities Earn More Interest?
The answer is in the fixed index annuity’s unique ability to earn interest. The annuity’s growth potential isn’t guaranteed, unlike what you get with bank products and guaranteed rates. However, over time, the annuity’s gains tend to exceed what the bank pays you, as the underlying index has good years (and bad years).
The “reset” feature for the fixed index annuity is also crucial. Again, your principal and credited gains are locked in each period. What’s more, the index’s current value is the new starting point for calculating interest. Your gains in a fixed index annuity can snowball more over time due to the reset feature.
Historically, fixed index annuities were designed to beat bank products and give retirees and pre-retirement savers an alternative with higher rates. And they have done just that. In fact, it’s not unusual for a fixed index annuity to be at a traditional fixed-rate annuity over time, and that is even with the annuity’s rate being guaranteed.
Is a Fixed Index Annuity or a Bank Product Right for You?
By asking the right questions and determining what is most important to you. Here are a few things to keep in mind:
- Bank products have FDIC coverage while annuities have backing of strict state-regulated reserves, reinsurance, and other safeguards at the state level. If you worry about ironclad protection, you might go with a bank product as it’s backed by the U.S. government.
- Compare the interest rates offered by bank products and fixed-rate annuities. Want more growth potential than what they pay? A fixed index annuity may indeed be right for you.
- If you need liquidity for your money, a fixed index annuity does allow some limited withdrawals, but doesn’t have the same liquidity as many bank products do.
- If you want guarantees for your retirement money and the peace of mind that they bring, an annuity (and perhaps a fixed index annuity) will certainly be of interest to you.
- If you plan to live off the money in your low-risk investment for retirement, an annuity is also worth a look if you are concerned about running out of money.
These points are to help you get started. If you are still wondering about what products make sense for the fixed-income or fixed-interest part of your retirement assets, consider talking to a financial professional.
The right financial guide will be someone who is experienced, independent, and knowledgeable about retirement. They should be able to help you build a customized retirement financial plan as they have for other clients. That includes looking at the mix of investments and savings vehicles, all working together, that makes sense for your situation.
Looking for a financial expert to assist you? You can connect with someone in our “Find a Financial Professional” section, where many independent and experienced financial professionals are available. Don’t hesitate to request a complimentary initial appointment and discuss your goals, concerns, and situation. If you need a personal referral, call us at 877.476.9723.