Indexed annuities are a special type of insurance and income-producing financial vehicle. With an indexed annuity, the return is based in large part on an underlying market index, such as the S&P 500.
Many indexed annuities will actually allow you to track multiple indexes from a list of options. There is also a fixed account alternative where you can place some (or even all) of your contributions.
Often referred to as a fixed indexed annuity or equity indexed annuity, these indexed annuities have quite a few moving parts. But, for the right investor, they can provide a long list of benefits – both before and after you retire.
As with other types of annuities, an indexed annuity represents a contract between an individual and an insurance company. In exchange for a premium payment (or multiple premium payments), the insurance company promises to pay the individual with an income stream in the future.
Indexed annuities can either be immediate or deferred. This means that the income can begin right away (or within 12 months of making your contribution), or alternatively, you can make one or more contributions and have the income begin at some time in the future.
Funds that are in the annuity’s account are allowed to grow on a tax-deferred basis. This means that gains will not be taxed until the time of withdrawal. Because of this tax-deferred concept, the account value can earn interest on your contributions, as well as interest on interest, and interest on the money that would have otherwise been paid out in taxes each year.
Indexed annuities may also offer other benefits, as well, such as a death benefit and/or the allowance of penalty-free withdrawals in the event that the annuitant (the person on whose life the annuity is based) is diagnosed with a terminal illness or must reside in a nursing home for a certain length of time.
If or when you want to convert the annuity to an income stream, you will typically have a number of options to choose from, such as:
Even though regular fixed annuities and fixed indexed annuities share several common features, there are some added bells and whistles that you could obtain with the latter – particularly with regard to the overall return in the account.
What really sets fixed indexed annuities apart from regular fixed annuities is the way that the return is calculated. For instance, while a regular fixed annuity’s return is based on a set rate, a fixed indexed annuity credits interest that is determined through a formula that is based on changes in the underlying index it is tracking.
By tracking a market index (or multiple market indices), there is the opportunity to obtain a much higher return with indexed annuities versus a regular fixed product. But it’s important to note that many indexed annuities include a “cap” or maximum amount of return that can be attained.
As an example, if the annuity has a cap of 5% and the underlying index returns 8% in a given time period, the annuity will only be credited with the 5%. There is a “tradeoff” here, though, because if the tracked index has a negative return in a given year, the annuity’s account value won’t incur a loss. Rather, it will simply be credited with a 0% for that period.
So, while there is no gain, there is also no loss – and because of that, future gains can build upon previous growth, but without having to first make up for any decrease in value. In other words, your gains in a fixed indexed annuity are locked in, never to be lost in the future, no matter what happens in the stock market. Given that, indexed annuity rates can typically be higher than the rates on a regular fixed annuity.
Many annuities come with option to add some additional benefits. This is usually done by adding various riders to the contract. Doing so can help you to better “customize” an annuity to more closely fit your specific needs.
There are several riders that you may be able to add to indexed annuities and that can enhance the overall benefits and the payout you get from it. These riders could include:
Many insurance and financial products charge fees. For instance, certificates of deposit will penalize you if you withdraw your funds before the CD matures. Even your checking and savings accounts my charge fees if you make “too many” withdrawals (or deposits!), use the ATM, or let your account balance fall below a certain dollar figure.
Annuities can also charge fees. The type and the amount of those fees will often depend on the type of annuity you have, as well as the insurance company you purchased it through. With regard to indexed annuities, the most common fee is the surrender charge you could incur if you withdraw some or all of your money from the contract during a certain time period known as the surrender period.
While all indexed annuity surrender charges can differ, typically these fees will start out higher (in some cases as much as 10% or 12% in the first year), and then they gradually decrease over time until they eventually reach 0%.
Many indexed annuities will allow you to withdraw up to 10% of the contract’s value each year without a surrender charge. It is important to note that if you take withdrawals from an annuity before you turn age 59 ½ – regardless of whether or not the annuity is still in the surrender charge period – you can incur an additional 10% “early withdrawal” penalty from the IRS. So, unless you have no other options, it can pay to keep your money in an annuity – at least until the surrender period has elapsed.
Over the years, there have been some indexed annuity complaints – many that centered around the fees that were being charged on the annuity. So, it is always recommended that you read all of the fine print before you commit to any type of annuity. Otherwise, there can be some problems with indexed annuities if you’re entering into uncharted territory.
Provided that you are comfortable with the inner workings of an indexed annuity, as well as with the long list of benefits it can provide, it may make sense to add this type of financial vehicle to your portfolio.
Some annuities have fees that may be buried deep in the prospectus and difficult to identify. If you need help calculating how much you are paying in fees, we do offer a complimentary annuity fee analysis for people that are concerned about paying too much in fees. Feel free to send us which annuity you would like us to conduct an extensive fee analysis on by clicking here. We have helped countless investors throughout the country save thousands of dollars in fees that were hidden in the annuity contract.
As employer-sponsored pension plans fade away, individuals are left with the responsibility of generating a significant portion of their retirement income on their own. An indexed annuity could help to solve that problem.
But, while indexed annuities can certainly provide some really nice benefits, these financial vehicles are not right for everyone. So, it is important to determine whether or not this type of annuity will truly help you to reach your short and long-term objectives.
Because all annuities should be considered as longer-term financial commitments, it is also recommended that you don’t contribute money that you may need to access in the near future for emergencies or other obligations.
So, if you’re still wondering, “Should I buy a fixed index annuity?”, talking with an experienced indexed annuities specialist should ideally be the next step. That’s where Sooner Retirement can help. We are a team of annuity experts. Our mission is to educate consumers on annuities so that they know exactly what they’re buying, and so that they know what to expect.
We also offer a multitude of annuity reviews on our website. These annuity reviews expose the good, the bad, and yes even the ugly about annuities. But we feel that knowing the whole story is really the only way for you to make a well-informed decision.
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