What is A Fixed Index Annuity?

Taking the Hassle Out of the Holidays

Many investors have opted for fixed index annuities as a source of retirement security. But what exactly is a fixed index annuity? And for that matter, how does it stack up against other financial options?

Comparatively, financial products such as CDs offer low return potential. They also don’t offer a guaranteed lifetime income option. And for seniors looking to bolster their retirement income, the ups-and-downs of the stock market puts retirement dollars at risk. After all, the market moves through cycles. Historical data shows it can take years for the market to recover.

A fixed index annuity offers protection from the effects of a falling stock market. Like any annuity product, it is a contract between someone and an insurance company for a specific period of time. You pay premiums to the insurance carrier, and in exchange you are given certain contractual guarantees and are promised periodic payments in the future.

The premiums you pay can be in the form of a one-time lump sum, or a series of payments. A fixed index annuity grants a minimum guaranteed interest rate, but what makes it unique is it is linked to an index. This connection offers the potential for higher interest earnings over time.

What is a Fixed Index Annuity: Other Details

The surrender period on a fixed index annuity tends to last 7-16 years. The fixed index annuity is tied to an index such as the Standard & Poor’s 500 index. There are no shares of any stock or of an index involved. The interest credited to the contract most often consists of a percentage of what the specific index did in an investment year.

Let’s say this particular index goes up. You would receive a set percentage of the index’s yearly change from when you paid into your annuity until one year from then. This set percentage can be subjected to a pre-set maximum. The interest is calculated with a formula based on changes in the index – the formula determines how much interest, if any, is credited.  

Like other fixed annuities, the fixed index annuity also comes with a minimum guaranteed rate (for instance, 1-2%). When the index goes down, it doesn’t matter if its interest rate is lower than the minimum guaranteed rate. The value of your annuity will not drop below the contract’s specified guaranteed minimum. The annuity’s principal and credited interest are not subject to market risk, either – with variable annuities, the principal can be at stake.

In short, in exchange for giving up some greater growth potential, you can mitigate market risk with a fixed index annuity.

Important Fixed Index Annuity Features

There are three primary features which influence a fixed index annuity’s index-linked interest rate. For more details, check out our Fixed Index Annuities content page.

• Indexing method – the method used to measure the amount of change within an index. These methods include the following: annual reset (ratcheting), high watermark, high water with look-back, short-term point-to-point, long-term point-to-point, monthly average, daily average, and monthly cap.

• Participation rate – the rate which determines how much of an increase in an index is used to calculate index-linked interest. Let’s say the change in the index is 10% and the participation rate is 70%. In this case, the index-linked interest rate for the annuity will be 7% (.1 x .7 = .07).

Participation rates can vary for newly issued fixed index annuities as much as by each day. The participation rate is set by the insurance carrier for a specified time period (often year-to-year or the entire period). When this period is over, the insurance carrier sets a new participation rate for the next period.

• Cap rate – Some annuity contracts will set a cap, or upper limit, on the index-linked interest rate. It is the maximum interest rate that the annuity can earn. Most fixed index annuity contracts have this feature as one of the index choices.

Fixed Index Annuity: Other Need-to-Know Information

Fixed index annuities also offer tax-deferred savings growth, give a guaranteed death benefit for beneficiaries, have an option for a guaranteed lifetime income, and are without annual contribution limits as long as they are flexible premium annuities. There are other benefits, too, but they can depend on the features of your specific fixed index annuity.

One downside is you have limited growth potential for the money in your contract. There are many fixed index annuity variations which may make it challenging to choose the right one for your needs. And in all annuity contracts, funds withdrawn before you’re 59.5 years of age are subject to a 10% penalty. Likewise, when they are withdrawn, earnings are subjected to taxation as ordinary income depending on your tax bracket at the time of your withdrawal.

Fixed index annuities can also differ. They may have different penalties for early withdrawals, may offer different index options, and may credit interest at different rates.

If you’re looking at a fixed index annuity contract, consider asking the following questions:

•    How long is my annuity’s term?
•    What is the contract’s minimum guaranteed interest rate?
•    What is the participation rate? How long is it guaranteed for?
•    Is there a minimum participation rate?
•    Does the contract have an interest rate cap? If so, what is the cap?
•    Does the contract have an interest rate floor? What is it?
•    Is interest rate averaging used? How does it work?
•    Is interest compounded during a term?
•    Are there any fees within the contract? If so, what are they? How do they arise?
•    What indexing method is used?
•    What are the surrender charges if a contract is ended early?

There are many options for fixed index annuities out there. Like with any financial decision, it’s best to take time to carefully educate yourself and plan.
If you’re ready for personal attention, meeting with a financial professional can help you clarify your goals and see if an annuity makes sense for your portfolio.

SafeMoney.com can connect you with someone to discuss your situation. They can help you determine whether a fixed index annuity can assist you with your lifestyle goals. Use our Find a Licensed Advisor section to connect directly with an independent financial professional, and to request a personal strategy session to discuss your needs and goals. And should you have any questions or concerns, call 877.476.9723.

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