Important Things To Know About Index Annuities (FIA)-5 Experts Weigh In

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An indexed annuity (or fixed indexed annuity, or FIA) is a class of annuities whose growth is based on the performance of a stock index. These annuities offer individuals the potential for higher gains with no risk of loss if the market declines. In this article, 5 financial experts discuss important things to know about indexed annuities.

Do Your Due Diligence On The Insurance Carrier And Get A Second Opinion On The Contract You Are Signing

“Fixed index annuities can serve a purpose within a client's overall portfolio. This could be used as a bond component to the portfolio that gives downside protection and promise of guaranteed income based on the contract and viability of the insurance carrier.

However, we do believe the main oversight by many clients looking to put the majority of their assets in a FIA is the inherent cost due to upside limits invoked by the insurance carrier plus the liquidity risk that is associated with the 5 to 7-year lock schedule. In many cases, the products are promoted as free. We believe this is completely fabricated and used as a selling tactic and nothing more. Let's all be honest, insurance companies are not charities. If you want the protection and guarantee that a FIA can provide we highly suggest you do your due diligence on the insurance carrier and get a second opinion on the contract you are signing.

As I mentioned earlier, this product should be used to supplement your overall portfolio as we do not ever recommend putting all or the majority of your assets in this type of illiquid product.”

Cody L. Lummus, Managing Partner, Delos Capital Advisors

Interest Earned Is Based On Movements Only In The “Price Index” Of Select Index Choices

“If a financial professional tells you that a fixed index annuity can compete with the stock market, it's time to consider looking for someone else.

A reasonable expectation for how much interest you might earn from a fixed index annuity is between 3% and 6%. Historically, equity market indices have earned an arithmetic average of 9% per year.

The interest that a fixed index annuity earns is based on movements only in the “price index” of select index choices. It doesn't include dividends being reinvested. Historical data indicates that reinvested dividends can add another 4% gain, on top of the asset value increase for a specific period, to the total return from equity market assets.

When you put money into a fixed index annuity, most insurance companies take at least $0.95 of every dollar you put in and invest it in conservative fixed-income assets. Those assets tend to be bonds, mortgages, and other low-risk interest-earning holdings.

The remaining money is invested in a call options strategy, which is tied to the index. How much interest your index annuity earns will depend on the options strategy, how long it lasts for, and the cumulative result of its performance from the starting day to the date when the contract expires.

If an advisor says that the index annuity is guaranteed to earn 10% or higher levels of interest, which is most likely a reference to the income benefit base that the insurance company will use to calculate its payouts to you.

This is an actuarial value used internally by the insurance carrier. It is not the walk-away cash amount you would receive if you chose to end the contract.”

Ian Myers, Communications Manager,

The Four Important Factors

“Investors should know these items before they purchase an FIA:

1) What are my fees?
Fees on fixed-indexed annuities are generally very low contrary to popular belief. The average fee on a fixed-indexed annuity is 1%. If you're paying more than 1-1.5% you're likely getting into a FIA that doesn't align with your investment reasons for getting into an annuity.

2) How do market gains/losses work?
Fixed-indexed annuities give the investor downside protection, meaning that you can't lose money due to market declines. In exchange for that downside protection, the investor will only receive a portion of the market gains. These FIAs will generally give you a cap, spread, or participation rate investment option. An example of this would be as follows: The capped option on the investor's FIA is 4%, the spread option is 2%, and the participation rate option is 50%. Let's assume the market increased 10% in the given year. If the investor were in the capped option, they would receive the 4% cap. If the investor were in the spread option, they would receive 8% (10%- the 2% spread). If the investor were in the participation rate option, they would receive 5% (10 x 50% participation rate). The investor generally has the option to blend their investment between a variety of these options.

3) What happens if I want to get out of my annuity contract?
There will be surrender penalties. These penalties last anywhere from 5-15 years are a percentage of the account balance. Once the surrender period is up, the investor can leave the policy without penalty.

4) What is my reason for wanting an FIA?
There are only three reasons someone should get into a fixed indexed annuity. They want income, they want to pass money onto their heirs, or they want protection from market losses. If the investor has objectives that do not meet one of these reasons, they should look for an alternative investment.”

Jordan Sester, Founder, J.S Financial Group 

Cap Rate, Surrender Charges, And Penalties

“Cap Rate/Surrender Charges- The most important things for index annuities are cap rate and surrender charges. They typically mirror an index like the S&P 500. Say the cap rate is 7%, the S&P does 12% year over year from the contract date, the client gets a 7% credit on the anniversary. If the S&P did 4% they get credited 4%. If the S&P was negative 30% they wouldn't see any credit or losses. Instead, they would likely earn a cash rate at 0.5% or so. You participate in some of the market gains but limit your exposure to losses.

Penalties- The insurance companies make money because they lock you in for typically 7 years or longer and the market averages up in all of these extended periods of time. They keep those spreads. They allow you to withdraw designated amounts, such as 10% of the value per year but penalize you for anything beyond that. Penalties can sometimes be double-digits. Money is tax-deferred, and you don't pay any gains until you withdraw from the contract. There is no fees upfront, and it's life insurance so you'd
name beneficiaries and it skips probate.”

Chane Steiner, CEO, Crediful 

3 Features That You Need To Be Aware Of

“Fixed Indexed Annuities have different risks and benefits. Being aware of these factors can help you decide if this FIA or any annuity, is right for you.

Fixed Indexed Annuities (FIA) offer a rate of return based on that of a specific market benchmark, like the S&P 500, but typically with a cap on the portion of the market’s return the owner will receive. Additionally, some indexed annuities are based on benchmarks that don’t include dividends, which can limit your total return.

There are 3 features that you need to be aware of.

1)Participation/Index Rate: The percentage of the underlying index’s return an indexed annuity holder is allowed to capture.

2)Performance Floor or Minimum Return: The minimum rate of return you will earn, typically tied to the long-term annualized average return of the market index underlying an indexed annuity.

3)Performance Cap: The maximum percentage increase allowed, which is typically tied to the long-term annualized average return of the market index underlying an indexed annuity.

Depending on whether you need your account to grow or provide income, a Fixed Indexed Annuity may be a good choice, but there may be more efficient, less restricted ways to reach your goals.”

Scott Krase, Founder and President, CrossPoint Wealth

As with any investment, there are benefits and disadvantages to indexed annuities based upon the objectives of an individual investor. If you are interested in an FIA, factor in what these financial experts have discussed and always do your due diligence before investing.

Sarah Bauder
Sarah Bauder

Sarah Bauder has a decade of experience at numerous publications, writing about finance, politics, economy and more.

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