What are fixed indexed annuities?
Fixed indexed annuities (FIAs) are insurance products that combine guaranteed protection from loss due to market downturns with the opportunity to earn interest based in part on any upward movement in one or more reference stock market indices, such as the S&P 500®.
FIAs help address volatility risk and longevity risk, two major concerns of clients in or near retirement. At the same time, they offer higher potential returns than fixed rate alternatives.
How do FIAs work?
An FIA may be a good choice for a client who is willing to forgo some growth potential in exchange for protection from market risk or losses. While it's possible to earn zero interest in any given crediting period, it will never be less than zero. In addition, once earned, interest credits are locked in and cannot be lost to any future downturns.
To provide that guarantee, FIA interest crediting methods limit participation in the underlying index. This usually comes in the form of a rate cap, spread fee or a participation rate.
- A rate cap is a ceiling applied to interest based on the index change. For example, an FIA with a 4 percent cap will receive an interest credit of 4 percent whether the underlying index returns 4 percent, 8 percent or 12 percent.
- A spread fee is deducted from an index return. For example, an FIA with a 2 percent spread will receive an interest credit that's two percentage points lower than the index's returns — 2 percent if the underlying index returns 4 percent; 6 percent if the index earns 8 percent; and 10 percent if the index returns 12 percent.
- A participation rate calculates interest credits based on a percentage of any index increase. For example, an FIA with a 90 percent participation rate will receive an interest credit of 3.6 percent if the underlying index returns 4 percent; 7.2 percent if the index earns 8 percent; and 10.8 percent if the index returns 12 percent.
Whatever the crediting strategy, money in annuities grows tax-deferred.* FIAs may also include riders that offer additional benefits, such as guaranteed income, a death benefit or liquidity options.
Who can benefit from FIAs?
The features and benefits of fixed indexed annuities mean that they can play a role in the retirement portfolios of many kinds of clients.
- People with a moderate tolerance for risk who want to protect their downside in volatile markets.
- Those who are willing to lock up a portion of their retirement savings for 5 to 10 years, in exchange for higher potential returns than those offered by other, more liquid conservative savings vehicles, particularly in a low-interest rate environment.
- Individuals seeking to secure a portion of their future retirement income through regular income payouts at the annuity's maturity date, or with a guaranteed lifetime income rider.
- People who have maxed out their 401(k)/IRAs and are looking for other sources of tax-deferred savings growth.
- Individuals who want to leave a legacy, because FIAs include a death benefit.
Fixed indexed annuities are designed to help meet a variety of client needs. With the benefits of growth potential, principal protection and guaranteed income to combat longevity risk, an FIA can be a valuable addition to a diversified retirement portfolio.
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*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 and a Death Benefit.