A fixed indexed annuity is an investment that allows assets to grow tax-deferred. This protects your principal, plus offers the potential to earn a rate of return that is tied to the market—but is not directly invested. A fixed indexed annuity may also be able to provide guaranteed lifetime income.
What are the benefits of a Fixed Indexed Annuity, or FIA?
An FIA can provide:
- Principal protection for your original investment, even if the market fluctuates.
- The potential for a guaranteed lifetime income stream, although this may require some additional structure and fees.
- A guaranteed interest rate that will never go below zero, even if market indexes go down.
How does an FIA work?
With a FIA, your money isn’t actually invested in the stock market. Instead, the insurer credits interest to your account based on a formula tied to an index’s performance over a set period, typically one year.
If the index rises, you receive a portion of that gain; if the index falls, you generally receive zero interest for that period rather than a loss. This is the primary appeal of FIAs: principal protection, and the potential for growth.
Different factors can affect how much of the index gain you receive, and insurers may adjust rates periodically (usually annually), within contract limits. So the terms in the first year may not be the same several years later.
How does a Fixed Income Annuity (FIA) affect my liquidity?
FIAs are intended to be long-term contracts. So most impose surrender charges if you withdraw money early over a specified amount (usually 10% annually). Surrender periods can be multiple years long, five to fifteen years. Some contracts include riders that waive charges should the investor’s circumstances change, such as illness or nursing home confinement.
With an FIA, withdrawals before age 59½ are generally subject to a 10% IRS early withdrawal penalty, in addition to surrender charges.
How does an FIA treat taxes?
Growth is tax-deferred. You pay no taxes on interest until you withdraw funds, then gains are taxed as ordinary income. This is different than capital gains, which are taxed at a lower rate. You should compare the tax value of an FIA to other tax-advantaged vehicles, like IRAs or 401(k)s, which may be more advantageous.
What about Fixed Income Annuity fees and riders?
A base FIA contract typically does not have a defined annual fee. The insurer’s cost is built into the cap and participation rates. However, optional riders, such as guaranteed lifetime withdrawal benefits or enhanced death benefits, typically carry additional annual charges, often in the range of 0.5% to 1.5% of the contract value.
Riders can reduce returns. So you must consider if their guarantees are worth the additional cost, and whether the FIA ultimately is the best choice for a longer-term investment. Riders can provide valuable guarantees but also reduce overall returns, so it’s important to understand exactly what you’re paying for and whether the guarantee matches your actual needs.
Who should consider an Fixed Income Annuity?
Fixed Income Annuities tend to appeal to people nearing or in retirement who want to preserve principal, avoid market losses, and still capture some growth potential, particularly for money they don’t need immediate access to. They can be useful when combined with other financial vehicles.
But they may not be a fit for anyone who needs more liquidity, or who may be young enough to weather the risk (and rewards) of market investments longer term.
FIAs can be complex, and the details matter enormously: cap rates, participation rates, indexing methods, rider costs, and surrender schedules all vary significantly between insurers. To effectively evaluate them, you must compare potential returns, potential changes over the course of the FIA term, and risks that may cause a need for money before the term ends.
Miser Wealth Partners can help you do a deep dive comparison into FIAs and other annuity products, to see which may be useful to you.
