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Indexed annuities: FAQ

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What is a fixed indexed annuity (FIA)?

A fixed indexed annuity (FIA) is an insurance product that combines protection from loss due to market downturns with growth potential as well as guaranteed lifetime income. A FIA gives clients the potential to accumulate interest without exposure to downside market risk by offering a guaranteed minimum interest rate, along with the potential for additional interest credits based in part on the performance of one or more reference stock market indices, such as the S&P 500®.

What indexing methods are commonly used?

A fixed indexed annuity's credited interest rate is calculated based in part on the upward movement of one or more major stock market indices. The most commonly used stock index is the S&P 500®. FIAs can also track alternative and custom indices.

How is the index-linked interest rate calculated?

FIA rates are set at the beginning of a crediting strategy's term period and are typically calculated based on mechanisms such as a participation rate or a cap. The participation rate determines the amount of an index's gain that will be credited to the policy value in the form of an interest credit. The cap is an upper limit on the amount of an index's gain in value that will be credited to the policy value.

How do FIAs provide downside protection from market loss?

Like traditional fixed annuities, FIAs guarantee a minimum interest rate. Thus, the annuity owner's premium incurs no market risk. What's more, any previously earned interest is also locked in and becomes part of the annuity's accumulated value.

How do riders affect FIAs?

Riders add further benefits or agreements to an annuity contract, generally for an additional charge. FIA riders vary depending on the specific product selected; they can include options such as guaranteed lifetime income or death benefits.

Are there tax benefits to owning an FIA?

Yes. Interest credited to an FIA premium is not taxed as earned income until it is withdrawn. When annuitized, a percentage of each annuity payment, known as the exclusion ratio, may be excluded from taxes. Annuity providers use IRS life expectancy guidelines to calculate this ratio.

Under current tax law, the Internal Revenue Code already provides tax deferral to qualified money, so there is no additional tax benefit obtained by funding a qualified contract, such as an IRA, with an annuity; consider the other benefits provided by an annuity, such as lifetime income or a death benefit.

Can individuals lose money in an FIA due to market losses?

Retirement savings in an FIA are not invested directly in the market and offer a guaranteed minimum interest rate. Thus, there is no market risk to an annuity premium.

What happens if individuals want to withdraw their money before the end of the term?

Annuity owners will pay a surrender charge if they withdraw a portion of or the entire contract's accumulated value during the surrender charge period. The surrender value is the amount in cash the owner is entitled to collect upon terminating the annuity contract prior to maturity or death. However, many FIAs allow individuals to withdraw earned interest or a percentage of the funds without triggering a surrender charge.

What types of individuals should consider an FIA?

Annuities can be a good option for the following types of people:

  • Those who are approaching retirement and have a lower tolerance for risk but still want some exposure to the stock market's growth potential
  • Those who are looking for higher potential returns than those offered by fixed income alternatives, particularly in a low-interest rate environment
  • Those seeking a guaranteed stream of income for retirement date
  • Those who have maxed out their 401(k)/IRAs and are looking for other sources of tax-deferred savings growth
  • Those who want to leave a legacy, because an FIA's accumulated value or minimum guaranteed contract value (MGCV) can be passed to beneficiaries at death. An FIA may also include an optional legacy rider.
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