Looking for a long-term, relatively risk-free savings option? Then you might consider a fixed indexed annuity. This is a financial instrument that provides investors with a guaranteed interest rate over a set amount of time. A fixed indexed annuity, also know as FIA, combines the low-risk nature of a fixed annuity with the potential returns of indexed annuities. Here are the pros and cons so that you can decide if a fixed indexed annuity is right for you.
Fixed Indexed Annuities: The Basics
A fixed indexed annuity is a long-term investment that provides investors with a guaranteed minimum interest rate over a set number of years paid out by the insurance company that issued it. FIAs also have the potential to earn additional interest based on market performance.This type of annuity is usually based on an index, such as the S&P 500, but can also follow other indexes as well, depending on investor preference. Any gains are locked in on an annual basis on the contract anniversary date. This is important to note because you may not see what you’ve earned until that date every year.
Fixed indexed annuities can be complicated though. They combine many of the characteristics of both a standard fixed annuity and a variable annuity. A fixed annuity offers investors a predictable return on the money they invest. A variable annuity offers investors the chance to invest in stocks, bonds and money market instruments. This comes with a higher level of risk and no guarantee of returns.
Benefits of FIAs
Perhaps the biggest benefit of a fixed indexed annuity is the guaranteed return and payout, similar to a Certificate of Deposit (CD). After all, isn’t that every investor’s bread and butter? More specifically, most FIAs offer a guaranteed return of 1-3% and 87.5% of the premium. This is why you often hear that these annuities have “principal protection.” This means that your initial investment is guaranteed, to a point. In this case, it’s around 87.5%.
Generally speaking, fixed indexed annuities offer investors a few major benefits. They provide a guaranteed income stream. This can be especially helpful in retirement when many are living on a fixed income. They also provide tax-deferred growth, portfolio diversification and relative protection on your investment, as mentioned above. Additionally, there’s the chance to earn additional interest based on market performance.
FIA Drawbacks
While fixed indexed annuities may seem like a great investment, they are actually complicated financial instruments.
For example, FINRA has warned investors that these guaranteed returns are only as good as the insurance company backing the FIA. Additionally, some FIAs can increase participation rates and other fees without notice to investors. This is another potential red flag because the amount that you may be able to earn through the additional interest in the market may be lower than you think after fees.