Indexed Annuities: What Are They? Should You Invest In One?

By |2013-12-11T22:33:17+00:00December 10th, 2013|Annuities|

indexed-annuitiesby Bill Broich

Indexed Annuities are also known as Fixed Indexed Annuities (FIA) and occasionally as Equity Linked Annuities (EIA). It is easy to become confused with the term “indexed” but the explanation is really quite simple. It means that your actual annual yield (interest earned) is tied to an independent third party source, such as the Standard and Poor’s 500 Stock Index (S/P 500). Your funds are NOT invested in the stock market; they are on deposit with the insurance company who issued the annuity.

What exactly is indexing? Indexing is simply an investment strategy that follows the performance of select securities, the S&P 500. Itis a collection of 500 American stocks which help measure the overall performance or benchmark of the US economy.

Think of it this way, you are outsourcing the yield for your annuity, trust a third party instead of taking what an insurance company decides to credit you.  It is really a hands off approach that uses an outside source to determining yields, a disinterested third party.

FIA are not for everyone and I will let you in on a little secret, your actual yields will not mimic the actual results of the S/P 500, your actual yields will be a percentage of the actual return. Is that fair?  Yes it is because for that reduced return you will never be exposed to loss or any risk of loss.  Your funds are fully guaranteed.

In the past you were offered only two choices about investing. Put your money in the stock market and be exposed to gains and losses. Or, deposit your funds in safe places such as banks and treasuries and earn a lower rate of return. You had your choice: safety or higher returns.

With the invention of the Fixed Indexed Annuity you were offered a wider choice, higher chances of yields but no chance of loss. Now you can have the best of both worlds: safety and yields.

If the S/P 500 has a down year and is worth less than it was a year ago (your anniversary) you do not participate in any downside movement, your account remains exactly as it was the previous time period, fully guaranteed from loss of principle.

Other benefits of Fixed Indexed Annuities:

Tax Deferral

The Power of Tax Deferral is the ability to defer any tax liability until a future date. Annuity values accumulate on a tax deferred basis until either withdrawn or inherited by a named beneficiary.  Your money can grow faster because the interest you earn is not taxed until a later date. “Annuity compounding” means you will continue to earn interest on you money and on the taxes which are tax deferred

Guaranteed Lifetime Income

Along with the protection from exposure to risk, FIA can provide you with a guaranteed income stream, an income stream that can be for any time period desired, even lifetime.  Most plans allow for the inclusion of a spouse so income can continue for both lives. Income riders are now available on FIA, these riders allow for better control over how an income is received and management of the actual money in the annuity. Numerous options exist to meet almost an income need of the annuity owner.

Stability

Annuities are safe, secure and stable.  Money in an annuity is managed by the general investment fund of the insurance company. The funds are invested in bonds, US Treasuries and often some stocks.  The company is absorbing any risk of asset performance by assuming all contractual promises to the annuity owner. This guarantee provides stability for your important funds, funds that need to be there for your retirement needs or your personal goals.

Guarantees

Annuities have layers of protection in place for the owner of an annuity.  The first is the insurance company itself.  An insurance company invests in conservative assets primarily bonds.  The bond portfolio can be corporate bonds, US Treasury bonds and municipal bonds. The second layer of protection is regulation. Insurance companies are some of the most regulated institution in the financial world.  They are audited by individual state departments of insurance who access the financial condition of the insurance company. Insurance companies are rated by independent rating companies such as A.M. Best Company, Standard and Poor’s and Fitch Ratings. The ratings services look deep into the assets and liabilities of the insurance company and assign a financial strength to them.  Generally any insurance company with at least a “B” rating has more than ample strength to meet any and all contractual obligations.

We have examined benefits and advantages of annuities, now let’s look at the disadvantages.  Remember annuities are not for everyone.

 Disadvantages of annuities

If you access your money in an annuity prior to age Pre-59 1/2 the IRS will add a pre-distribution tax penalty of 10 percent.  Annuities are designed to be used later in life, after age 591/2

Surrender penalties: Almost all annuity contracts have a penalty for early withdrawal much like a bank certificate of deposit. Annuities are longer term commitment (generally a minimum of 5 years) so if an insurance company holding your funds is an issue, then an annuity may not be for you.

Investments held for a time period may qualify for a capital gains tax liability which is generally less than an ordinary income tax liability.  Annuities are tax deferred vehicles and do not qualify for capital gains treatment.

Annuities are not included in step-up in basis at death.  Current tax laws allow for non-qualified assets such as stocks, bonds, and real estate stock to have a tax basis change at death to whatever the current value of the asset.

 

Is an annuity right for you?  It all depends on how an annuity will be used in your specific situation. Make certain you fully understand the details of your annuity as well as the benefits you can enjoy.

You can obtain our free “Safe Money” book and a no-obligation annuity quote by filling out the form on this page.

 

About the Author:

Bill Broich
Bill Broich is a well-known annuity expert with over 30 years of experience. He has written hundreds of articles on annuities and other financial topics, and has been a featured commentator on TV, Radio and the Internet. To follow Bill's profile, click here.