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How Fixed Index Annuities Can Protect Your Money

how fixed index annuities can protect your money

With markets in turmoil right now, many retirement savers are looking for ways to protect their money now so they can retire later. And not for just any retirement. They want a comfortable retirement that they can enjoy on their own terms and where they stay retired.

What can you do now to preserve the money you have accumulated and grown for so many years? The answer will be different for every person. It depends largely on their situation, risk tolerance, need for liquidity, and goals.

But one proven solution is a fixed index annuity. Backed by the protection of sturdy, long-time insurance companies, fixed index annuities are a place where you can park your can't-afford-to-lose money and sit tight.

A Great History of Protecting People's Money

Life insurance companies have a great track record of protecting their policyholders' money. They must maintain, at minimum, dollar-for-dollar reserves for every dollar of annuity premium they bring in.

Life insurers are also regulated on the types of investments they can use for supporting their annuity policies. For fixed annuity insurer risk pools, the bulk of dollars go into Treasury securities, high-quality corporate bonds, and other low-risk fixed-income assets.

Insurance companies also are subject to creditor ratings. They have those published on a regular basis by very reputable ratings agencies such as A.M. Best and Moody's.

Think about it. Did you ever ask your local stockbroker what his creditor rating is? Or ask the advisor at the local branch of your bank? How about at the local office of a massive investment services company?

This isn't a knock against stocks or market-based funds. After all, every asset class can have a place and role in someone's portfolio. But it helps point out a key difference among life insurance companies, investment companies, and other financial institutions.

Insurance companies are judged by their ability to manage risk. From 1982 to 2010, only 291 out of thousands of health and life insurance companies failed.

In other words, they got to a point where state insurance regulators had to step in and take over the company's claims to make good on their insured promises to policyholders.

How a Fixed Index Annuity Can Benefit You

Now, what about you as an individual retirement saver? A fixed index annuity allows you to protect your principal against index losses while enjoying some growth potential for your money. This growth will be tied to an underlying financial benchmark.

For many indexed annuities, this benchmark is the S&P 500 price index. But most fixed indexed contracts today usually have several different benchmark indices to choose from.

Note the index doesn't include dividends. This is an insurance contract, not an investment.

When the underlying index goes up, your annuity money earns interest based on a proportional percentage of that increase. When the index goes down, the least you can earn is zero percent.

Zero is your hero. Your money doesn't lose value due to the underlying index dropping. The insurance company simply credits you nothing for that time period. 

How Do Fixed Index Annuities Work?

You can’t lose the interest money you earned in a prior crediting period if the index declines in a subsequent period. Once interest has been credited, it’s locked in permanently, regardless of how the index performs from then on.

However, in exchange for this protection against index losses, the life insurance company limits the growth potential of your money.

Caps, participation rates, and spreads are the levers at the insurer's disposal for this. This helps the insurance company manage the risks of its promises to you, including shouldering the risk of investment loss.

More on Caps and Participation Rates

Caps limit the amount of growth that you can earn to an absolute percentage, such as 5 percent.

So if the underlying benchmark index rises by 25% during a given crediting period, then you will only earn the maximum of 5% for that period. The insurance carrier keeps the remainder of the growth.

Participation rates have no absolute limit, but you only earn a percentage of all of the growth in the index from day one.

For example, if the participation rate is 70%, then you will be credited with 70% of the growth of the index during that period. So if the index rises by 10% during the crediting period, you will be credited with 7% of the growth. (10% X 70%).

Spreads are simply a charge that would be deducted from the growth. So, if the index grew 10% during that period and the spread was 2%, your money would earn 8% interest for that crediting period.

How Much Could Your Money Grow?

Historically, fixed index annuities have had more growth potential than bonds, CDs, and other fixed-income assets.

With traditional fixed annuities, insurance companies often pay you 20-30% more interest than what the bank might give you in its products. This is quite a nice alternative.

A fixed indexed annuity is designed to have more growth potential than a fixed annuity. Some of the most competitive index annuity contracts in the insurance market have earned 3 to 6 percent interest over the long term.

However, the growth potential will depend largely on your specific index annuity, its contract design, and what interest rates are at in the larger financial market.

Some fixed index annuities are built to pay out more lifetime income than other contracts. Meanwhile, others are built for accumulation above the growth potential of fixed-interest instruments.

Ask your financial advisor or agent what the purpose is for any index annuity contracts you are considering. Matching the right solution to your specific needs is what is most important.

Can You Lose Money with a Fixed Index Annuity?

One of the few ways that you can possibly lose money in a fixed indexed annuity is to make a withdrawal from the contract that exceeds the free withdrawal amount in a given year.

All fixed indexed annuities come with a backend surrender charge schedule. This helps the insurance company prevent "runs" on annuity policies so it can maintain its strong guaranteed promises to you, the policyholder.

Some surrender periods stretch out as long as 15 years. But not all, as some contracts have much shorter surrender periods.

Also, most fixed indexed contracts will also allow you to take out a certain amount without penalty each year. Usually this is as much as 5 or 10 percent of the contract value.

But if you withdraw more than that amount in a given year, you may face surrender charge penalties on the excess amount withdrawn. However, once the surrender charge schedule has expired, the annuity is liquid and can be cashed in without further penalty.

Keep in mind that ordinary income taxes can apply to your withdrawals and potentially a cash out.

See How You Can Protect Your Money

Fixed indexed annuities are one of the newer types of annuities in the marketplace. After all, they have "only" been available for about the past 25 years.

Annuities have been around since the days of the Roman Empire. But fixed index annuities are rapidly becoming the most popular type of annuity because of safety of principal and their ability to earn fairly competitive interest.

Consult your financial professional for more information about fixed indexed annuities and how they can help protect your money. What if you are looking for a financial professional to help you? No sweat.

Many financial professionals are available at SafeMoney.com to assist you. Use our "Find a Financial Professional" section to connect with someone directly. You can request an initial appointment to discuss your goals and situation. Should you need a personal referral, call us at 877.476.9723.

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