Fixed Index Annuity Pros and Cons
What is a Fixed Index Annuity?
There are a few types of annuities but today we will focus on fixed indexed annuities. First, an annuity is an insurance product that is used to provide a guaranteed retirement income stream that you can’t outlive. A fixed index annuity credits interest based on the return of a stock market index, usually the S&P 500. A FIA usually has a floor (or minimum) of 0-1% – which means that you have complete market downside protection, your principle can never go down due to a market correction (the insurance company assumes the risk). Using this strategy, a FIA can provide higher earning potential than a regular fixed annuity.
The Pros of a Fixed Index Annuity
- Growing potential without the risk – a FIA usually has a a minimum guaranteed return of 0-1%. When the stock market index is negative, the 0-1% minimum interest is credited instead of your principle going backwards.
- Interest is credited based on a stock market index – most FIA’s use the S&P 500 as a benchmark for how much interest to credit your account up to the cap rate. Instead of sticking your cash in the bank or in a bank CD, money market, or buying bonds and really limiting your growth, you will have higher earning potential using a FIA. Many companies have rolled out uncapped rate options.
- Guarantees – FIA’s are equipped with a guaranteed minimum return. They can produce a guaranteed retirement cash flow that you can’t outlive, creating a dependable income source in retirement. The guarantees that come with an annuity are some the biggest reasons why people choose to purchase one or rollover their IRA or old 401k into annuity.
- Tax Deferral – a FIA provides tax deferred growth, meaning you won’t pay any taxes on the growth until you access your money. This is an advantage over a bank CD, which does not receive a tax friendly treatment.
- Premium Bonus – many annuities offer enticing bonuses on any premiums made within a certain time period. For example, if you were to purchase your annuity with $100,000 and there was a premium bonus of 10%, you would receive a $10,000 bonus that vests over time. This bonus would apply to all monthly, quarterly, or annual premiums as well.
- Flexibility – an FIA has flexible penalty free withdrawals and you can make unlimited contributions which isn’t so with a 401k or IRA.
- Bypass Probate – another awesome benefit of having an annuity (or life insurance) supplementing your retirement is because they bypass probate. Cash passes directly to the beneficiary.
The Cons of a Fixed Index Annuity
- Fees – annuity fees are actually very nominal. You can purchase an annuity that has ZERO fees but it may not come with a guaranteed income rider. Many income riders cost .75%-1% in an annual fee.
- Surrender Period – the “catch” you can say to purchasing an annuity is that there is a surrender period, usually between 3-14 years. During this period any cash that is withdrawn over the free withdrawal percentage is subject to surrender fees.
- Surrender Fees – if you withdraw any cash over the free withdrawal limits (usually between 5-10% annually) then you will have to pay surrender fees. Surrender fees can be as high as 15% in the first contract year and they usually reduce by 1% every year of the contract.
- Moderate Earning Potential – FIA’s are not to be compared to stock market investments. They will provide moderate growth for those that are seeking safety of their principle.
Does a Fixed Index Annuity make sense for me?
If you are looking for safety, growth, and a guaranteed lifetime retirement cash flow then a FIA makes perfect sense. It sure beats the heck out of a bank CD that pays you 1%, having your cash sitting in the bank, or stuffing it under your mattress!