Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

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Jeffrey G. Sweno, MBA
First Vice President
Wayne Hummer Investments

Fixed Index Annuities (FIAs) have become very popular in the last couple of years, in part because they are a combination of what many consider the best aspects of the other annuity types. They share many features of both the fixed and variable annuity without many of the downsides: guaranteed rates, no stock market loss, potential for gains, and tax-favored accumulation.

Many annuity contracts offer the opportunity to select a fixed rate. In addition, or as an alternative to the fixed rate, an index option may be selected which provides an annual return that is benchmarked to an equity index such as the S&P 500. The index option is subject to rate floors and caps, meaning it will not exceed or fall below a specified return level even if the underlying index fluctuates outside of those parameters. In addition, there are options that allow for future lifetime income streams.

Today, a healthy 65 year-old female has a 50% chance of living until age 85. For a couple where both reach 65, there is a 50% chance that at least one of them will live to 89 and a 25% chance of at least one of them lives well into their 90s. Retirees concerned about outliving their investments can protect themselves by creating a guaranteed income stream. This can be accomplished through annuitizing the FIA contract, or a more popular option today is to set up a withdrawal program utilizing an income rider. For an additional fee, the income rider can be added to an annuity that provides a future lifetime income stream of 4% or 5%. During the accumulation phase, most riders offer a guaranteed growth rate that rolls up every year between 5% and 10%. Rollup periods range anywhere from 7 to 20 years.

In all, FIAs offer numerous advantages, including no 1099 income during accumulation, the opportunity to earn higher rates than CDs or fixed rate annuities (when choosing the index option), and insulation from loss of principal, which often impacts government bonds and bond mutual funds. In addition, most FIAs do not have upfront sales charges or M&E costs. Fees will only be applied if the annuity is surrendered early or if a rider is purchased.

Disadvantages include complexity, as many contracts offer riders and options that often require the assistance of a qualified professional to explain. While FIAs do offer the potential for higher returns based on market performance, there is usually a cap limiting the upside. Potential gains are typically capped at somewhere between 3% and 7% (e.g. if an annuity has a cap rate of 6% and the benchmark index is up 12%, the FIA return is limited to 6%). On the other hand, in years where the index is negative, the FIA return will be 0%.

Is a fixed index annuity right for you? The answer is, “maybe”. Only you know your goals for retirement, so only you can determine your needs. If tax deferral is important to you, indexed interest potential appeals to you, and you like the concept of protection benefits that can help protect your retirement assets and income, then a FIA may be the right solution for you. Given the complexity of many contracts, especially ones with income riders, you should always consult with an investment professional before making a decision to purchase.