A Beginner’s Guide to Fixed Indexed Annuities
Are you a retiree or a soon-to-be looking for an investment with a guaranteed income stream? Fixed Indexed Annuities may be the right choice for you. An indexed annuity is a type of financial product that offers guaranteed income streams and the potential to earn money based on market performance. Read on to learn more about how indexed annuities work, the benefits of investing in them, and things to consider before making your decision.
What is an Indexed Annuity?
A Fixed Indexed Annuity is an agreement between you and an insurance company that can protect your retirement savings from losses due to market downturns while still allowing you the potential to benefit from a percentage of gains in market indices. It does this by linking your investments’ performance to one or more external indices, such as the S&P 500 Stock Index, and generally capping any potential gains. In exchange, the insurance company provides you with no market exposure, and your funds on deposit are guaranteed.
How Indexed Annuities Work
When investing in a Fixed Indexed Annuity, your premium payments can be exchanged for an income stream from the insurance company. The amount of the income streams depends on the amount of your deposit, the performance of the annuity, your age and your state of residence. The gains are calculated by participation rate, spread/margin/asset fee, and interest-rate cap. The participation rate determines what percentage of the index’s gain will be credited to your account each year. Once credited, the value of the annuity fund is guaranteed. For example, if your participation rate is 40% and the linked index earns 10%, then 4% will be credited to your account. The spread/margin/asset fee is a small fee taken out before crediting any index gains into your account; this helps cover administrative costs associated with managing the account. Lastly, the interest-rate cap sets the maximum amounts earned each year.
There are also three different methods used to measure how much money will be added to your account each year: annual reset, point-to-point, or high watermark. Annual reset involves taking note of where the index closes at the end of every year and resetting it back to zero so that all future returns are measured against that baseline number; point-to-point measures changes in index values over time without resetting anything; high water mark involves setting a threshold where no new earnings can surpass this threshold until there is another increase above it (similarly to hitting peaks on a mountain range).
Considerations When Investing in Indexed Annuities
When investing in a Fixed Indexed Annuity, there are some essential considerations to ensure it’s right for you. First, withdrawal charges may be associated with taking early withdrawals from these accounts; if not specified directly by contract, they may default as high as 10%. Most contracts allow for a penalty-free withdrawal annually; your specific contract would contain the limits of this benefit. Additionally, when attempting to withdraw funds early, they may incur tax penalties that could further reduce potential earnings. Therefore it’s important to understand what fees or penalties may apply and plan out when withdrawals should occur so that they occur at optimal times (i.e., after retirement age). Speaking with an annuity professional will help you get the full details, answer any questions, and ensure you get the right product.
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