Indexed Annuities Offer Growth, Protection and an Income Stream
Indexed annuities have gained popularity, particularly among those nearing retirement, as they offer market-linked growth while protecting the principal regardless of equity and interest rate fluctuations. These annuities also provide a lifetime income option, ensuring regular payments throughout retirement.
However, before committing to an indexed annuity, it is crucial to understand how they work to avoid unexpected surprises if the annuity does not perform as anticipated.
What is an Indexed Annuity?
Indexed annuities are insurance and income-producing financial vehicles that derive their returns from an underlying market index, such as the S&P 500. They offer multiple index tracking options and a fixed account alternative for contributions. Indexed annuities provide several benefits for the right investor, both before and after retirement.
These annuities are contracts between individuals and insurance companies, where premium payments secure future income streams. They can be immediate or deferred, allowing for immediate or future income initiation. The funds in the annuity account grow on a tax-deferred basis, earning interest on contributions and accumulating interest on interest.
Indexed annuities may also include additional benefits such as death benefits and penalty-free withdrawals in specific circumstances, such as terminal illness or nursing home residency.
When converting the annuity to an income stream, various options are available, including life-only, period certain, life with period certain, and joint and survivor options. These options provide ongoing income for the annuitant's lifetime or a specified period and offer flexibility for beneficiaries.
Regular Fixed Annuities vs Fixed Indexed Annuities
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.
Enhancing Indexed Annuity Payout with a Guaranteed Income Rider
adding riders to annuity contracts allows for customization based on specific needs and can enhance the overall benefits and payout of indexed annuities. Some riders commonly available for indexed annuities include:
Guaranteed Minimum Income Benefit (GMIB): This rider guarantees a minimum payout in the future, regardless of market performance, ensuring a set amount of income.
Guaranteed Minimum Accumulation Benefit (GMAB): The GMAB rider guarantees that the annuity's income value will be at least a minimum percentage of the contributed amount over a specific period.
Guaranteed Minimum Withdrawal Benefit (GMWB): The GMWB rider guarantees that a certain percentage of the annuity's contribution can be fully recovered, regardless of actual performance.
Guaranteed Lifetime Withdrawal Benefit (GLWB): The GLWB rider guarantees a set percentage of the annuity's account value as income for life.
It's important to note that the income rider is separate from the annuity's contract value and cannot be accessed as a lump sum. Understanding whether a stated guarantee applies to the contract value or the income rider is crucial.
Other riders for indexed annuities may include:
- Death Benefit Rider: Provides a named beneficiary with the remaining principal of the annuity in the event of the annuitant's death, potentially with added interest.
- Inflation/Cost of Living Rider: Increases annuity income over time to keep pace with rising inflation.
- Return of Premium Rider: Guarantees that a beneficiary will receive the remaining paid-in premiums.
- Long-Term Care Rider: Allows additional income or penalty-free access to the annuity's premium in the case of residing in a long-term care facility. When considering annuity options, it's advisable to evaluate the available riders and their suitability for your specific financial goals and circumstances.
Understanding Indexed Annuity Fees
Annuities, including indexed annuities, can charge fees that vary depending on the type of annuity and the insurance company. One common fee associated with indexed annuities is the surrender charge, which is incurred if you withdraw funds from the contract during the surrender period. Surrender charges typically start higher and gradually decrease over time until they reach 0%.
Indexed annuities often allow for penalty-free withdrawals of up to 10% of the contract's value each year. However, early withdrawals before reaching age 59 ½ may incur an additional 10% penalty from the IRS.
It is important to carefully review the fees and terms of any annuity before committing to it. Complaints regarding indexed annuities have been related to the fees charged, so understanding the fine print is crucial to avoid potential issues.
If you are concerned about annuity fees, there are services available to help analyze and identify the fees associated with your specific annuity contract.
When considering adding an indexed annuity to your portfolio, it's advisable to be comfortable with its inner workings, benefits, and potential fees.
Who Should Consider a Fixed Index Annuity?
Indexed annuities can be a potential solution for individuals who are responsible for generating a significant portion of their retirement income. However, it is crucial to assess whether an indexed annuity aligns with your short and long-term objectives before making a decision.
Considering that annuities are long-term financial commitments, it is advisable not to contribute funds that may be needed for emergencies or other immediate obligations.
If you are still unsure about whether to buy a fixed indexed annuity, seeking guidance from an experienced indexed annuity specialist can be beneficial. Annuity Gator is a resource that provides annuity education and reviews to help consumers make well-informed decisions.