Fixed Index Annuities - Good or Bad?
By Hersh Stern - October 25, 2013
Uncertain economic times and the need for guaranteed income during retirement may have made you feel uneasy about investing in volatile investments like stocks and bonds. You may be considering a fixed index annuity as a means of providing all or some of your household’s needed income. But, the amount of information available about fixed index annuities can be overwhelming for many. Let’s take a closer look at how this annuityworks and how it may or may not benefit you. (See examples of fixed index annuities in the table below.)
Understanding Interest Rate Caps and Floors
The single largest benefit to a fixed index annuity is principal protection. Interest credits are deposited into the annuity account annually based upon the underlying index’s performance. Most fixed index annuities provide you with an interest credit floor, meaning the percentage deposited into your account annually will never fall below this figure, despite the performance of the underlying index. Additionally, the insurer guarantees the investor’s premium deposit will not decline in value.
To balance this out, fixed index annuities include rate caps, placing a ceiling on the amount of interest growth to be deposited during any given investment year, even if the underlying index outperforms this figure. In addition to rate caps, due to the nature of an annuity, you will not participate in the underlying stock index dividend payments. This is one of the biggest concerns advisors have with fixed index annuities; the perceived limited upside potential for your investment.
Fixed Indexed Annuities- Other Considerations
One of the benefits of annuities in general is tax-deferred growth. You are not taxed on the growth of your premium deposit until it is withdrawn at a later date. Annuity withdrawals are taxed as ordinary income. This is in contrast to the interest earned on a bank certificate of deposit which is taxed even if you don't withdraw it.
Annuities are designed to provide income at a future date to the contract owner. Therefore, they should be considered long-term, illiquid investments. Most contracts include a surrender schedule for varying period of time following premium deposits. Once the noted time period has passed, you can access your funds without these fees.
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Important Notice: This information is not intended to be a recommendation to purchase an annuity. You should consult with a financial planner to determine if an annuity is a suitable product in your situation. Also, be advised that tax information published at this site is written to support the promotion of annuities. It is based on limited facts and should not be relied upon. You should consult with your own tax and legal advisors for an opinion about what could or should be done in your particular situation.