Fixed indexed annuities (FIAs) are designed to provide investors with a low-risk way to earn a reasonable rate of return on their investment while still providing protection against market volatility. In this article, we will explore what you need to know about fixed indexed annuities and when they can be a positive addition to your investment portfolio.
What is a fixed indexed annuity?
A fixed indexed annuity is a type of annuity that is designed to provide investors with a return on their investment that is linked to the performance of a specific market index, such as the S&P 500. Unlike traditional fixed annuities, which provide a fixed rate of return, FIAs can allow investors to participate in the potential upside of the market without exposing themselves to market risk.
How do fixed indexed annuities work?
FIAs are a popular financial product that has gained a lot of attention in recent years. In fact, according to LIMRA, the first quarter of 2023 showed record-breaking sales for FIAs of $23.1 billion, up 42% from first-quarter 2022 results and 4% higher than the record set in the fourth quarter of 2022, which exceeded the previous record set in 2008 during the height of the global economic recession.
When you purchase an FIA, you are essentially buying a contract that promises to pay you a return on your investment that is based on the performance of its underlying index.
Unlike variable annuities, fixed indexed annuities are not actually subject to market risk. FIAs work by crediting interest to the policy owner based on the terms outlined in their particular contract. Sometimes the credited interest amount is capped, but some FIAs are uncapped. Some policies have a floor or a minimum interest rate that gets credited to the policy regardless of how the market performs.
One of the most appealing aspects of FIAs is that the credited interest amount—usually credited annually but sometimes more or less often—gets added to the contract’s principal, so the growth of the FIA has the chance to compound. And with any FIA, even if the market experiences a significant downturn, your principal will not be affected based on the strength of the insurance company issuing your contract.
Why choose a fixed indexed annuity?
FIAs can be an excellent option for investors who are looking for a low-risk way to earn a reasonable rate of return on their investment. They provide investors with the potential to earn returns that are higher than traditional fixed annuities while still providing protection against market volatility.
In addition to their low-risk profile, FIAs also offer other benefits, such as tax-deferred growth, guaranteed minimum rates of return and the ability to provide a steady stream of income during retirement.
When might a fixed indexed annuity be the wrong choice?
If you haven’t acquired a lot of retirement assets, it’s important to remember that fixed indexed annuities are not liquid and they come with surrender charges during your first years of ownership, depending on the contract terms. You should always keep cash reserves for emergencies and have other sources of income. You may want to think of a fixed indexed annuity as an option to some of the bond funds in the fixed portion of your retirement portfolio, except that with fixed indexed annuities, you have a guarantee against the loss of principal from an insurance company.
Some annuities offer lifetime income either as part of the policy itself or as an optional rider to it for an additional cost. For healthy retirees worried about longevity and running out of money at some point, this can be a welcome feature, but it may not make sense to invest a lot of money in an annuity if you are not well. Some annuities offer a death benefit option, so that if you pass away early, your heirs at least receive some benefit from your purchase.
In conclusion, fixed indexed annuities are entering the mainstream as an optional asset class. They can be a positive addition to a retirement portfolio, offering a low-risk way to generate retirement income and earn a reasonable rate of return on principal while still providing protection against market volatility. FIAs can even be a good option for younger investors who are looking for a safe and reliable way to grow and protect their wealth over time.
This article originally appeared on Forbes: “Fixed Indexed Annuities: What to Know“
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.