Have you ever wondered, “Should I buy a fixed index annuity?” If so, it was probably because a financial advisor had proposed one to you.
First, there is nothing wrong with a fixed index annuity. So if you are looking for an article that is going to say, “All annuities are bad!” well you’re not going to find it here.
Having said that, there are many times that annuities are used incorrectly in an investor’s overall portfolio. This is a shame for 2 reasons: 1) Investors suffer and 2) It gives all annuities a bad name.
So to help you answer the question, “Should I buy a fixed index annuity?” I’m going to make it easy by breaking this discussion down into some simple components. If you have a current advisor that is recommending you buy a fixed index annuity, then you need to understand how to make the best decision.
The advisor you are working with should help you understand if it will be a good decision. If he/she doesn’t, then use this article to help you know if a fixed annuity is right for you.
First… “What Is A Fixed Index Annuity?”
Let’s start with a definition of this type of annuity.
It is “Fixed” which means that it is NOT “Variable.” It does not have any market risk associated with it. If you buy a fixed index annuity and the stock market goes down, you will not lose money. In other words it is “conservatively” invested money.
Second, it includes the word “Index.” All this means is it will track an index (usually the S&P 500 but there are other options available now). If the index your annuity tracks goes up, you can earn interest.
Remember this: “It is interest that you earn.”
You do not earn dividends because you are not invested in equities. Instead you earn interest. However, the interest that you earn on your annuity will be based on how well the index (like the S&P 500) does.
Your money is not invested in a security that tracks the index. Your money is not invested in mutual funds or stocks.
A fixed index annuity is guaranteed by the issuing insurance company. Securities like stocks, ETFs, and mutual funds are not guaranteed. You can lose your money with those investments. Not so with a fixed index annuity.
Lastly is the word “Annuity.” It is a contract with an insurance company. The insurance company must abide by the terms of the contract. Any guarantees they put into the contract, they must honor.
How Does A Fixed Index Annuity Work?
The way this type of annuity works is that you have limited participation in whatever index you track. But you have full 100% downside protection. So if your funds in the annuity are allocated to track the S&P 500 index, then if the index performs well you may be credited interest to your annuity on the contract anniversary date. If the S&P 500 goes down you will not lose money.
Will your money have the potential to grow as much as the S&P 500? No. But there may be some unscrupulous (or unknowledgeable) advisors that may hint that you will get this type of growth.
So don’t expect to knock it out of the park with growth. That’s not the purpose of a fixed index annuity. The trade-off is that you don’t have your money exposed to the market risk of investing in a mutual fund or ETF that mimics the S&P 500. In other words, you can’t lose money in this investment.
With most fixed index annuities you will also be given the option to allocate some of your funds into a “fixed account” if you don’t want to allocate your funds in an index tracking method.
What this means is you can allocate some of your funds into a guaranteed return option. And the interest rate will typically be good for one year. At the end of the year you will have an offer for a different guaranteed fixed rate. If you use this “fixed account” option it doesn’t matter what the index does. You will receive the stated interest rate on your money. This stated interest rate will typically be less than what you could potentially get from allocating into an index account, but it is guaranteed.
Who Should Buy A Fixed Index Annuity?
Now we get to the million dollar question. “Who should buy a fixed index annuity?”
Well, annuities do some things very well. If you need any of the following benefits, then a fixed index annuity may have a place in your overall portfolio.
First, they can be used as a conservative accumulation of wealth strategy that protects your principal. Since they are guaranteed by the insurance company you can’t lose money. They were designed to compete with bank CD’s and potentially give you slightly higher returns than CD’s.
Also, since they are annuities the interest you earn is tax deferred until you pull it out of the annuity. This allows your earnings to accumulate better than if they were getting taxed every year.
Second, they can provide guaranteed retirement income. Some fixed index annuities give you the option to attach an income rider to them. Generally speaking, what this rider does is give you a guaranteed amount of income in retirement that you can never outlive, even if your annuity value drops to zero.
Typically the longer you wait before taking income off the income rider, the higher your lifetime guaranteed income will be. This can help you out a lot when you are planning for your retirement income in the future.
Third, some fixed index annuities provide limited long-term care benefits. They typically do this by taking the income rider that I just mentioned and doubling the income you receive from it.
So if you have an income rider that will guarantee to pay you $10,000 annually for the rest of your life, it can double to $20,000 annually if you are confined to a nursing home or can’t do 2 out of 6 activities of daily living.
The annuity contract may allow this doubling to go on for 3 to 5 years. After that the annuity would revert back to $10,000 annually in income. Make sure you check (or have your advisor show you) the fine print. Not all annuities will give a full doubling.
Fourth, some fixed index annuities provide a way for you to maximize what you leave to your heirs. Now granted, life insurance is probably the best way to pass down your legacy assets. But some people are not healthy enough to qualify for life insurance.
Some fixed index annuities can be used as an alternative way to maximize your legacy. Some will give you the option to have the death benefit of your annuity increase by a percentage each year guaranteed. So if you put in $100,000 and the contract allows it to grow by 4% of the original deposit each year, then after 5 years the death benefit would be $120,000.
If your health keeps you from qualifying for a better legacy option, like single premium life insurance, then this is a good alternative.
Do you need help determining if you should buy a fixed index annuity?
It can be confusing trying to figure out if a fixed index annuity makes sense as part of your portfolio. But keep these things in mind before making a purchase:
- Understand what the purpose of the annuity (or any financial product) is in your overall plan before making the purchase.
- If you are being told by an advisor that you will have the potential to make a lot of money with a fixed index annuity, don’t buy into it. That’s not the purpose of a fixed index annuity. They do other things very well, such as the 4 points listed above. Use them for those purposes.
Do you know someone that is being advised to purchase a fixed index annuity? If so share this article with them. It’s a great way to lend them a helping hand. By all of us pitching in together we can help more people make better choices, which ultimately can give them a better lifestyle.
If you have a Facebook account you can share this article by simply clicking the Facebook icon on the left of the screen. That is a quick and easy way to share this with your friends and family.
And lastly, if you need help determining whether or not you need a fixed index annuity in your retirement plan, then feel free to reach out to me. Is an advisor recommending that you purchase one but you aren’t sure what to do? I’ll help answer your questions.
You can easily grab a spot on my calendar for a 20 minute phone conversation by CLICKING HERE. I’ll help answer your questions and point you in the right direction.
In your service,