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What retirement savers need to know to get the most from a fixed indexed annuity

by Susan Wright | Contributor
July 14, 2020

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Back in the early 1900s, Henry Ford issued his famous statement that, “Any customer can have a car painted any color that he wants so long as it is black.” That didn’t leave a lot of options. Today, however, vehicles come in a plethora of colors. They can offer a wide range of features, too, so that buyers can choose the one that is best for their particular needs and their budget, even though they all essentially perform the same service – getting you from Point A to Point B.

The same holds true regarding fixed indexed annuities, or FIAs. While these financial vehicles can offer a stream of reliable income, as well as tax advantaged growth, not all of these annuities are exactly the same.

But even though these differences can allow you to pick and choose the annuity that most closely fits your objectives, unless you have a good understanding of how FIAs work, you also run the risk of picking the wrong one – and if this is the case, it can be fairly expensive to get out of it and into a better alternative.

How do fixed indexed annuities differ from one another?

Much like houses all have some type of foundation, fixed indexed annuities can for the most part perform the same functions. These include growing the account based on the performance of one or more underlying market indexes and allowing for the payout of an income stream.

But this is where many of the similarities – at least with fixed indexed annuities – stop. In fact, there are several ways in which fixed indexed annuities can differ – sometimes quite substantially – from one another, such as:

  • Tracked index(es). The return on a fixed indexed annuity is determined in large part by tracking one or more underlying market indexes such as the S&P 500. But even though this index is oftentimes used as a benchmark of performance, a growing segment of the FIA market is now made up of fixed indexed products that track alternative, or “hybrid,” indexes, like the MSCI EAFE Index. In fact, there are actually more than 40 different indexes that you may find as tracking options with a fixed indexed annuity. In addition, while some FIAs only provide one underlying index to track, others will allow investors to choose from a variety of index-tracking alternatives. Typically, having a more diverse index selection can provide you not only with more choice, but also with more control.
  • Capped returns. Because fixed indexed annuities keep your principal safe – even in a downward moving market – there is usually a “tradeoff,” which typically comes in the form of limited growth. For instance, a “cap” is a maximum percentage rate of growth that will be attained, even if the underlying index has a stellar performance in a given year. As an example, if an FIA imposes a cap of 5%, and the index being tracked attains 10% for a given contract year, the return is limited to the amount of the cap, which in this scenario is 5%.
  • Participation rates and spreads. If a participation rate and/or a spread is included, it could further reduce the annuity’s overall return. For example, the participation rate is the percentage of the index’s return that will be credited to the annuity’s account. So, if the underlying index attains a 10% return in a given year, and the participation rate is 44%, then the return will only reflect 4.4% (because 44% of 10% = 4.4%). The example below reflects the value of $100,000 contributed to an FIA that tracks the S&P 500 index and has a 44% participation rate.

Likewise, if a spread is imposed on a fixed indexed annuity, it could also reduce the amount of interest that is credited to the account over a specific period of time. In this case, the amount of return is determined by subtracting a certain percentage from any gain that the underlying index(es) achieves within a given period of time (usually during a contract year). In this case, if the annuity imposes a spread of 4% and the index increases 10% during a contract year, then the FIA could receive a 6% return (although if there is also a cap and/or participation rate, the overall could differ, oftentimes reducing it even further).

Can you add more value to an FIA with a volatility control option?

Many investors have been enticed by fixed indexed annuities because of their ability to reign in market volatility by allowing for limited upside potential and at the same time limiting (or better yet, eliminating) losses when the tracked index(es) go into negative territory.

So, while the S&P 500 is a commonly used index for determining an FIA’s return, over the past few years, “volatility controlled” indices have also come into the limelight. This type of index will often track a “basket” of assets that change regularly, with the goal of making the index fluctuate up or down less than the S&P 500.

It is important to keep in mind, though, that different insurers will typically use their own unique indices. So, here again is yet another feature that can make fixed indexed annuities differ – sometimes significantly – from one another. Working with an annuity specialist can help you to sort this out.

Are you ready to take a closer look at fixed indexed annuities?

Fixed indexed annuities can offer a long list of advantages – and given their ability to provide market-linked return without any of the downside risk, it can seem like these financial vehicles provide a “best of both worlds” scenario.

But that is really only partially true. In fact, regardless of the benefits offered through an annuity, if it’s not the right one for you, it could end up being a costly financial endeavor. With that in mind, discussing your short-term and long-term objectives with a retirement income specialist is the best place to start, before making a commitment to an annuity.

Alliance America can help

Alliance America is an insurance and financial services company. Our financial planners and retirement income certified professionals can assist you in maximizing your retirement resources and help you to achieve your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.

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