Fixed Index Annuities: Pros and cons

By linking annuity returns to an external index such as the S&P 500, Fixed Index Annuities (also known as equity-indexed annuities) are those that contracts with annuity providers that combine the benefits of fixed and variable annuities. This is because they provide safety to annuity investors while facilitating participation in the financial market. Equity indexed annuities are marketed as alternatives to both fixed and variable annuities. As such, they inherit some of the merits and demerits of both.

Base guaranteed rates

Fixed annuity contracts usually offer guarantees on contributions and returns. This is one attribute that is offered with Fixed Index Annuities. Although annuity investors have greater participation in the market, they are somewhat insulated from severe losses or sharp downturns.

Even though base rates can be utilized, this does not completely insulate annuity investors from losses. Why? This is because the guaranteed amount would not match the contributions in the initial stages of the growth phase. Indeed, in several instances in takes years for the guaranteed amount to match the premiums invested. Yet another important caveat is that a fixed index annuity is only as safe as the annuity provider that offers it.

Higher returns

Fixed Index Annuities facilitate higher returns through market participation. They allow the investors to benefit from favorable market fluctuations and offer higher rates than Certificates of Deposit and Money Market Funds.

The constraint of this benefit is that the terms of the contract can limit the extent to which the benefit of higher returns trickles down to the investor. Features of FIAs like interest rate caps, margins and participation rates determine the level of returns on the particular contract. In addition, indexing methods are also critical in either minimizing or maximizing returns on equity indexed annuities.

Taxation

Like some other annuity contracts, fixed index annuities may be qualified – meaning tax exempt. Qualified annuities offer tax-deferred growth, meaning that contributions and returns are tax-exempt in the accumulation phase. Having tax deferred growth allows superior fund accumulation.

The primary demerit of deferred taxation is that withdrawals/payouts are not tax-exempt. Early withdrawals have stiff penalties and annuity payouts and distributions are regarded as income. This means that payouts are subject to higher tax (income tax as opposed to capital gains tax).

Fund management

Normally, to participate in the financial market, you’d need a bit of time, savvy investment strategies or the aid of a financial advisor. Owning a fixed index annuity contract provides this benefit to investors immediately. However, fund management also goes hand-in-hand with fund management fees. Such fees might be relatively obscure to the average investor and can significantly reduce the real returns. Although fund management is convenient, it does not provide annuity investors with much control over how their premiums are invested.

Guaranteed lifetime income

This benefit is not unique to fixed index annuity contracts. As with other annuities, this benefit comes at a considerable price. One of the demerits of guaranteed lifetime income is that the income is fixed and subject to inflation and tax risks.

Fixed Index Annuities can be a valuable addition to your financial plan or retirement fund portfolio. Annuity investors must be careful not to perceive or use FIAs are investment instruments, since they are annuity contracts. The best strategy with Fixed Index Annuities is to optimize the benefits while minimizing the costs.