Understanding the Complexities of Fixed Indexed Annuities

Fixed indexed annuities have a lot of pieces and parts.  They are more complex than the fixed annuity products that came before them.  In The Aiken Standard article, “On the Money: Equity-indexed annuities are popular but complex,” Greg Roberts defines the terms that are associated with fixed indexed annuities and offers basic annuity refreshers.  Annuities are contracts between you and an insurance company.  You purchase this product with a lump sum or a stream of payments and the insurance company makes payments to you for a period of time or your lifetime.  An immediate annuity pays you right away, while your payments come in the future with a deferred annuity.  Deferred annuities have an accumulation phase before you begin receiving payments and then a payout phase.

Annuity products can be fixed or variable.  Fixed annuities guarantee an interest rate during your accumulation phase and then guarantee your payments.  They also have tax advantages and sometimes offer credits if interest rates get higher while you are in your deferral phase.  Your interest rate with variable annuities is dependent upon your annuity’s investment accounts.  Variable annuities are considered securities and are regulated by the SEC.  Fixed equity indexed annuities are a hybrid of these two types of annuities.  You typically receive a guaranteed minimum interest rate or are at least guaranteed that you will not lose your principal.  Your interest is also linked to a stock market index.  You take on less market risk than you do with variable annuities, but have the potential to gain in the markets unlike with fixed annuities.  While indexed annuity sales are regulated by state insurance departments, many people think that these products should also be regulated by the SEC like variable annuities are.

Indexed annuities have a lot of different features that can affect how much interest you receive.  Make sure that you know all of the complex moving parts associated with your fixed indexed annuity so that there are no surprises.  Participation rates are the percentage of any stock market gain that you will receive.  Ideally, you would like a 100% participation rate so that you could take advantage of any gains in the markets.  Many indexed annuities offer 90% participation rates.  Some indexed annuities have an interest rate cap.  This cap means that you cannot earn more than that much interest in any time period.

A spread, sometimes called a margin, is an amount that will decrease any percentage of market gains you receive.  If your fixed indexed annuity has a spread of 5%, your gain would only be 1% if your index increased by 6%.  Each insurance company uses a different indexing method with their fixed indexed annuities.  Ask questions from your advisor so that you understand the indexing method associated with your product.  Most fixed equity indexed annuities guarantee your principal and some even guarantee a minimum interest rate credit.  Indexed annuities have surrender charge periods around 5 to 10 years, so it is important to make them a long term investment to avoid paying surrender charges.  Fixed equity indexed annuities might be the right tool for your personal financial plan, so speak with an expert to help you understand all of their features and terms.

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