Understanding Fixed Index Annuities

By Cathy DeWitt Dunn

What is a Fixed Index Annuity?

A fixed index annuity (FIA) is a contract between you and an insurance company. Set up properly, they may help you achieve long-term retirement goals. First, you provide a lump sum (premium payment) to the insurance company. In exchange for your premium payment, the insurance company provides you with future income. The major benefits of a FIA include:

• Principal and credited interest accumulate while participating in potential gains from the stock market
• Principal protection from against market losses
• Guaranteed lifetime income
• Tax deferred earnings

The FIA Process

You must know about the two phases to a FIA process to better understand fixed index annuities. The first is the accumulation phase and second is the payout or distribution phase. The accumulation phase begins when you purchase the annuity. During this phase, your account value earns interest. Earnings are based partly on a fixed interest guarantee and partly on the gains, if any, in a stock market index. The interest credited to your account is not taxed until the distribution phase. If a financial emergency occurs during the accumulation phase a fraction (usually about 10%) of the total premiums can be withdrawn without penalty. However, a more significant or full withdrawal triggers surrender charges. The potential surrender charges decrease the longer the annuity is held.

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The distribution phase begins when you decide to receive income from the annuity. There are a number of payout plans that include fixed guaranteed monthly payouts during your lifetime. Some options include a lump-sum payout, payouts to beneficiaries after your death, and nursing home benefits. You decide the best distribution method based on your needs now and in the future.

Principal Protection

You are guaranteed a total payout at least equal to your initial premium payment. Regardless of your payment plans or your life expectancy, the original amount you invested is protected. An important optional feature for you may be the death benefit. This means that if you pass away before you receive payouts from your account, your beneficiary receives either fixed payments or the value in a lump sum. Keep in mind that all guarantees are based on the claims-paying ability of the issuing company.

Benefits of Understanding Fixed Index Annuities

The benefit from having credited interest based partly on stock market gains can be substantial. In other types of annuities, credited interest is based on the following: a predetermined fixed interest rate, the gain or loss associated with mutual fund type investments, or variable interest rates. In a fixed index annuity, part of the return is based on a stock index that you choose, typically the S&P 500.

For example, if the index you choose increases during the year, a portion of that increase is applied to your account. The portion applied is determined by one and in some cases two factors. Some fixed index annuities have a cap interest rate that can be applied. For example, if the index rises 12% for a year but you had a cap of 8%, then you would receive the 8% credited interest. If the index rises only 5% then you would receive the 5%.

Some fixed index annuities have a participation rate. This defines what percentage of the index gain is applied to your account. Let’s say there is a 10% gain in the index and the participation rate is 80%. Then, a credited interest of 8% is applied to your account. It is possible to have both a cap and a participation rate that are applied after the cap rate.

A third rate option is called a spread. A spread is available for some fixed index annuities where a fixed interest rate amount is subtracted from the index gain before applying interest to the account. If the spread was 3% and the gain for the index was 10% then 7% would be applied to your account.

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The Next Steps

The primary reason fixed index annuities are far outselling other annuity types is because they benefit from gains in the stock market index. In addition, they protect against any losses. All gains applied during previous years and in future years are locked-in and preserved. They are not affected by single or multiple yearly losses in the stock market.

Are you better understanding fixed index annuities? Are FIAs right for you? Possibly. Certainly one upside is there is no downside. If your financial goals are long term and the benefits mentioned appeal to you, contact us at (972) 473-4700 today.

Disclosure: Indexed annuities are insurance contracts that, depending on the contract, may offer a guaranteed annual interest rate and some participation growth, if any, of a stock market index. Such contracts have substantial variation in terms, costs of guarantees and features and may cap participation or returns in significant ways. Any guarantees offered are backed by the financial strength of the insurance company, not an outside entity. Investors are cautioned to carefully review an indexed annuity for its features, costs, risks, and how the variables are calculated. A fixed annuity is intended for retirement or other long-term needs. It is intended for a person who has sufficient cash or other liquid assets for living expenses and other unexpected emergencies, such as medical expenses. A fixed or indexed annuity is not a registered security or stock market investment and does not directly participate in any stock or equity investments or index.

Guarantees and benefits are subject to the claims paying ability of the issuing insurance company.