Our own Andrew Murdoch, also President of Somerset Wealth Strategies, wrote an article for Marketwatch to explain “Why fixed indexed annuities are strong sellers.” Sometimes fixed indexed annuities are described in a too good to be true way. Yes, they offer principal protection while still exposing your money to stock market gains. But keep in mind that you won’t take advantage of total stock market gains because your money is not only linked to an index, but often subject to caps and participation rates. This isn’t all bad though because for many consumers, the good outweighs the bad when it comes to fixed indexed annuities. This is why indexed annuity products have been soaring in popularity and some experts think they might even surpass variable annuity product sales.
The article says that fixed indexed annuities are the right product for many pre-retirees and retirees alike. Their sales were up 22% in the third quarter of last year while overall annuity sales were up 3%. This indexed annuity increase was the main reason that there was any increase in total annuity sales at all. Variable annuity sales were down 9% in the same quarter. Since variable annuities offer full exposure to the markets, an underperforming market and a strong memory of what happened in 2008 has kept many people away from variable annuities. Indexed annuities take away the downside risk and also provide some exposure to the markets, even if it isn’t 100% exposure. These products are good for people who want some market exposure, but are too nervous to fully invest in the risky markets. Fixed indexed annuities also protect your income with riders that pay generous lifetime income to those who own the products.
Indexed annuities are like a fixed annuity with a variable component. The variable rate of return is based on how the index that the annuity is linked to performs. Most FIAs pay a guaranteed minimum income benefit (GMIB) along with offering upside potential. There are people who opt to buy their FIA without the GMIB just to take advantage of the potential to earn more than they would with a traditional fixed annuity product. You only earn a portion of any stock market gains no matter which type of fixed indexed annuity product you purchase.
Participation rates set the percentage of any gain you will receive, caps can put a limit on the total gain and spreads can deduct some of the gains from your actual earnings. Each indexed annuity has different rates, caps and spreads and may not have all three. Despite the fact that your indexed annuity doesn’t keep up with rapidly increasing markets, the benefits often outweigh this main drawback. Another drawback often associated with fixed indexed annuities is their longer than average surrender period. These annuities often have a surrender time frame longer than those with other annuity products. This is just one of the reasons that annuities in general are meant as a long term investment.
Indexed annuity crediting methods can often be confusing, but it’s important to understand them. Fidelity Investments did a study that looked at the returns during 2013, which was the best market year in over three decades for the S&P 500. With dividends included, investment returns were 32.4%. An average fixed indexed annuity paid 10% that year. This is the most extreme example, however, most yearly returns would be much closer. But what you have to consider is that 2013 could have been a terrible year in the markets where investors lost a significant portion of money. Those holding fixed indexed annuities would still have had a small gain, protected their principal and maintained their income benefit.
So despite the potential drawbacks that some people see with fixed indexed annuities, Murdoch says that savvy purchasers believe these are insignificant. Have realistic expectations when you are purchasing an indexed annuity and you won’t be let down. Lifetime income riders are one of the main reasons that people buy fixed indexed annuities. The potential market gains are an added benefit. If you are not looking for the lifetime income benefits, you are hoping for better gains that a fixed annuity offers but need the principal protection for your mental well being. People are flocking to fixed indexed annuities for their principal protection, guaranteed lifetime income and potential market gains.
Written by Rachel Summit