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How To Invest Risk-Free for Retirement With a Fixed Index Annuity

Nov 28, 2023

Blueprint Income Team

Managing risk is an essential part of creating a retirement portfolio.

Making the right financial decisions when planning your portfolio can ensure that you have financial security during your retirement. While there are a variety of retirement savings vehicles out there, fixed index annuities are a unique option that offers both security and the potential for growth. 

A fixed index annuity offers you a way to save for your retirement without putting your capital at risk. Fixed index annuities do not directly expose your portfolio to the market. Instead, they use market indexes as benchmarks to determine the interest credited to your account. The added security can make it a great way to contribute toward your retirement.

Fixed index annuity for retirement

A fixed index annuity is a long-term savings option that guarantees capital protection and future income. The security of this annuity can make it a great retirement savings vehicle.

Fixed index annuities can ensure that you receive a guaranteed income during your retirement while also exposing your annuity to market-related growth prior to your taking income. Also, your contributions grow tax-deferred, which allows them to grow faster than they would if they were subject to taxation every year. A portion of your future payments will be taxed as ordinary income during your retirement.

What is a fixed index annuity?

A fixed index annuity provides you with the protection of a fixed annuity along with the potential for higher returns that are linked to the performance of a market index, like the S&P 500.

Market indexes track the performance of a group of stocks or investments. Large indexes like the S&P 500 include 500 of the largest companies in the United States. By linking your annuity's interest to a market index, you can gain some exposure to the market and potentially achieve higher returns than a fixed annuity.

How a fixed index annuity differs from other annuities

A fixed index annuity is a unique option that offers you both security and the potential for growth. Here's a quick look at how fixed index annuities compare to other kinds of annuities.

Fixed annuity

A fixed annuity is a financial tool that allows you to earn a fixed return on your principal. A fixed annuity typically declares an interest rate that is effective for a certain period of time, after which a new rate – higher or lower – is credited.

Just like a fixed annuity, a fixed index annuity guarantees your capital and future payments. Unlike a fixed annuity, a fixed index annuity links its interest to a market index. It may also have a minimum rate (e.g. 0% or 1%) that is credited during periods in which the market index loses value or is otherwise less than the minimum crediting rate.

Variable annuity

With a variable annuity, your funds are invested in the market. This means that the value of your annuity can rise and fall depending on the underlying investment's performance. Unlike a variable annuity, a fixed index annuity comes with a minimum crediting rate that guarantees your principal  even if the market index goes down.

Benefits of a fixed index annuity for retirement

Here are the upsides to contributing to a fixed index annuity:

Lifetime income

You can structure the income paid from your fixed index annuity in various ways. An annuity can be structured to pay out over a certain period of time or for the rest of your life. If you choose to receive payments for the rest of your life, the payments are calculated using your life expectancy.

Protection against market losses 

A fixed index annuity secures and guarantees your capital and future income payments. Your contributions are protected by the insurance company that you bought the annuity from. Fixed index annuities protect your principal and accumulated earnings by guaranteeing a minimum crediting rate when the market is down. In this way, your retirement savings are not at risk.

Opportunity for higher returns

Fixed index annuities are credited with interest that's linked to a performance of a market index. If the market index rises, so will your annuity's interest. This correlation empowers your fixed index annuity to grow with the market (subject to limits) and potentially achieve higher returns than some other kinds of annuities.

Tax-deferred growth 

Earnings within a fixed index annuity are tax-deferred, meaning that your annuity can grow faster than a similar investment whose earnings are taxed every year. When you enter the payout phase of your annuity, these future payments will then be taxed as ordinary income.

Beneficiary provisions

There are also inheritance benefits that come with a fixed index annuity. The death benefit is the simplest option that pays out the annuity value to any designated beneficiary. There's also an enhanced death benefit that you may be able to choose that increases the death benefit by a certain percentage every year.

In the annuitization period (when you begin to receive payments), your annuity could also pay using the "life with period certain" option. This is where a beneficiary can receive a specified number of payments if you die before the minimum payment period.

Risks and considerations of a fixed index annuity for retirement 

Consider the following if you're interested in contributing to a fixed index annuity:

Limited liquidity

A fixed index annuity is not as liquid as other investments. If you need funds urgently, withdrawing early from a fixed index annuity will affect your current cash values or future payment amounts and can come with added fees and penalties.

Gains can be limited

Fixed index annuities benefit from having interest credited based on the performance of a market index. However, the interest crediting option is essential to define how much of the index performance affects your annuity's interest. The process of interest crediting differs between fixed annuities and index annuities. Index annuities, unlike fixed annuities, have more limitations and variations in their interest crediting methods. These limitations are necessary for insurers to offer principal protection.

For example, a cap rate is designed to protect insurance companies from losses. This is the maximum interest that your fixed index annuity can be credited with during any given period. If the cap rate is set at 6% and the index goes up by 10%, your annuity will be credited with 6%.

Similarly, a participation rate is the proportion of any index increase that is credited to your account. For example, if the participation rate for your annuity is 70%, and the market index rises by 10%, your annuity's credited interest will be 7%.

Understanding the surrender period

The surrender period is a set period of time where charges can be applied for withdrawals. Insurance companies typically charge a percentage of your asset value, with the the percentage decreasing over time.

As an example, if you have a seven-year surrender period, the insurance company may have a charge of 8% in the first year, 7% in the second, 6% in the third, and down to 0% in the seventh year.

Considering your distribution options

There are a variety of distribution options that come with a fixed index annuity. You can choose a lump sum payment, a systematic withdrawal structure, or the annuitization method. The annuitization method guarantees your income payments for life. period certain (e.g., 10 years) or a combination to the two (e.g., lifetime income, guaranteed at least 10 years).

Making the Most of Your Fixed Index Annuity

Here's how to experience maximum benefits from an FIA:

Planning for withdrawals and income

It's important to prepare for the payout phase of your fixed index annuity. Besides choosing the right distribution option, it's important to understand how payments are taxed. Since earnings within the annuity were tax-deferred, a portion of your future payments are taxed as ordinary income during your retirement.

Optional annuity riders

Annuity riders are added options that can enhance your annuity contract. These riders can help tailor your fixed index annuity to your financial needs.

Is a Fixed Index Annuity Right for Your Retirement?

Here's how to determine whether an FIA is right for you.

Weighing the pros and cons 

It's important to take a close look at the pros and cons of the fixed index annuity to make the right decision for your retirement. These kinds of annuities guarantee your principal along with future payments during your retirement, while also exposing your annuity to potential gains in the market. 

The main risk of a fixed index annuity is that the credited interest is tied to the performance of a market index. If the index performs poorly, the rate can go down to the minimum guaranteed rate. This could see your annuity grow at the minimum crediting rate, which could be lower than other annuities.

Evaluating your overall retirement portfolio with an annuity

While there are various retirement savings vehicles to choose from, a fixed index annuity offers a unique option that guarantees an income for you in the future with the potential for index returns. Managing risk is a key component of creating a retirement portfolio. In this way, adding this kind of annuity can reduce your risk and guarantee a source of income during your retirement.

If you want to learn more about how a fixed index annuity can help you during your retirement, Blueprint Income is here to help. Visit our website for more information, or get started today with our intuitive guide.


Blueprint Income Team

We are a team of finance, insurance, and actuarial professionals working to make it easier for everyone to achieve a steady and comfortable retirement. We write about annuities (the good and the bad) and provide strategies to help Americans prepare for retirement.


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