A fixed indexed annuity sounds like the best of both worlds — an income which doesn’t stop and the ability for that money to grow, as it would in the market. But, the insurance companies and brokers sell them for very high fees with lots of caveats.
- A fixed indexed annuity offers guaranteed interest rates on your savings like a CD or fixed rate annuity, however this interest is offered by insurance companies, not banks
- The extra money you can generate in the market is limited by caps, spreads, and participation rates
- A fixed indexed annuity premium will generally generate much less income in a fixed indexed annuity than with a traditional longevity or immediate annuity.
A fixed indexed annuity, otherwise known as a FIA, is an insurance product which produces a pension-like guaranteed income in retirement while also offering some liquidity and the opportunity to benefit from market growth. This product sounds like the best of both worlds — an income which doesn’t stop and the ability for that money to grow, as it would in the market. But, the insurance companies and brokers sell them for very high fees with lots of caveats, which significantly reduce the value that you could receive from your retirement savings.
First, let’s break down how a fixed indexed annuity works:
A fixed indexed annuity offers…guaranteed (fixed) interest rates on your savings.
Like a CD or a fixed rate annuity, a fixed indexed annuity offers a guaranteed interest rate on your savings over a set period of time. However, unlike CDs, fixed indexed annuities are offered by insurance companies, not banks. The interest is also not taxed until you actually start withdrawing the money, which has to happen after age 59 ½ because it’s meant for retirement. At the end of the interest accumulation period, you can choose to convert the accumulated value into an income annuity.
A fixed indexed annuity offers…limited market growth for your savings.
The premium you pay for a fixed indexed annuity also tracks the market, in one or more different indices. That’s where the “index” part of the name comes from. This tries to ensure that if the market does well, your money will also grow, and produce a better income, but if the market doesn’t do well, you will still have the initial guaranteed income.
However, the extra money you can generate is severely limited by “caps”, “spreads”, and “participation rates” which are different ways that insurance companies can take a portion of the growth.
A fixed indexed annuity can eventually become…an income annuity.
An income annuity is a contract between you and an insurance company. In exchange for a one-time premium, the insurance company promises to give you a steady, guaranteed paycheck for life, like a pension. The size of the paycheck is specified when you purchase, and depends on factors such as how much premium you paid, your age, and gender. However, the same amount of premium will generally generate much less income in a fixed indexed annuity than with a traditional longevity or immediate annuity. This is because FIAs offer a lot more features. This is not automatic however; this is an option you can choose at the end of the interest accumulation period.
There are a significant number of disadvantages to a fixed indexed annuity.
- The growth that insurance companies promise from investing some of your money in the market is stunted by lots of limits insurance companies will place. These are called caps, spread, and participation rates, and we’ll go into them later.
- Any extra features you add to your fixed indexed annuity will bring down the amount of guaranteed income you will receive.
- The more guarantees you add to actually secure the lifelong income stream, the more you give up the “savings account” type liquidity that makes a fixed indexed annuity look attractive in the first place.
- Fixed indexed annuity are very hard to compare across insurance providers, which makes it difficult to understand which product is actually right for you. They can vary by (1) where your money is invested, (2) how much of the market gain you are allowed to benefit from, (3) extra features, (4) credit rating of the insurer, and more.
- They offer extremely high commissions to the person selling it to you, so your distributor may have a greater incentive to sell it to you even if it doesn’t fit your financial needs.
In the end, by trying to do everything at once, the fixed indexed annuity doesn’t do either of its functions very well: providing a guaranteed income stream or growing your savings in the market.