Historically, fixed indexed annuities have gained favor with investors who like the idea of participating in market gains while protecting their principal. Couple this with a guaranteed stream of income in retirement and it’s not hard to understand why these annuities have been the most popular product in retirement planning. In recent years however, indexed annuity sales have flattened after the Depart of Labor’s fiduciary rule focused on the commission based sales of the product. But with the demise of the DOL’s rule, and others that were similar, fixed indexed annuities are now poised to make quite a comeback.
Fixed Index Annuities Explained
Fixed Index annuities differ from investing directly in the equity markets in that they offer principal protection in exchange for limitation on potential investment gains. While the concept is simple, these products typically carry complex features that a potential client will have to evaluate. One of the most important of these choices is the interest crediting method, which determines the way interest is credited to the account value.
One of the most popular options is the annual point-to-point interest crediting method. This simple method compares the beginning index value to the ending index value on the contract’s anniversary date, and the percentage of change is calculated. If the ending value is higher, the client will receive interest. If it’s lower, no interest will be credited.
Fixed Index annuities often include a cap or a spread. A cap controls the amount of credited interest a client can collect. For example, if the index gained 10% and the cap is 6%, only 6% will be credited. On the other hand, if the gain was 1%, the client would receive the 1% credit because it’s less than the cap. A spread is subtracted from the value of the gain. If the index gained 10% and the spread was 5%, the account would be credited with 5% interest. If the index gained 1%, no interest would be credited because the spread is greater than the gain.
There are other crediting methods, like the high water mark method or point-to-point method, but many do not credit interest until the end of the investment term. This can be devastating if a decline in value near the end of the term causing a loss of earlier increases in value.
The Future of Fixed Index Annuities
The Setting Every Community Up for Retirement Enhancement (SECURE Act) was recently passed in the House addressing employers’ concerns with annuity investment offerings and fiduciary responsibility. As a result, it is expected that annuity options in 401(k)s will become much more popular in the near future.
Even though the DOL fiduciary rule was taken off the table, the impact remains. As a result a newly developed fee-based fixed indexed annuity class has emerged replacing some of the commission-based products. With the commission removed, higher cap levels are now being offered. But before you are attracted to higher cap levels, be aware that the earning potential of some fee-based fixed indexed annuities can end up the same because of the fee charged based on the account’s value.As always, before purchasing an annuity product, it is recommended that you discuss the details and pros and cons with a trusted financial advisor. It is crucial to educate yourself and read all of the small print before signing on the dotted line. For more information about fixed indexed annuities, or other annuity products, visit our website at www.annuityfyi.com.
Written by Rachel Summit