Are Fixed Indexed Annuities A Worthy Investment Option?
by Abdul Aziz Mondal Finance 11 April 2023
Investing in your future, especially for your retirement and old age, is one of the most important things you should start looking into as soon as you start earning. The sooner you start, the better the chance you have of beating the ever-growing inflation rate.
Out of the many investment options out there, fixed-indexed annuities are a popular choice due to their safety and stability. However, are they really the best place to park your retirement money? Let’s find out.
What Are Fixed Indexed Annuities?
A fixed-indexed annuity is an investment option that provides you with regular payments from the performance of an underlying index such as the Russell 2000. When you invest in FIAs, you hand over your money to an investor (usually an insurance company) that will invest on your behalf in a portfolio of assets.
You can choose to invest in an annuity contract as a lump sum or through regular payments. The choice is up to you. Most of the time, there is no limit on how long you can invest, and a lot of people choose to invest in their FIA until retirement.
When they reach retirement, they cash out, either in the form of monthly outs, usually for the rest of their lives, or in the form of a lump sum.
With that said, it is important that you are aware of the pros and cons of fixed index annuities and what you are actually getting into before you start investing. Let’s start with the benefits first.
One of the main benefits that come with this type of investment is that the insurance company guarantees that your principal amount will not decrease in value, regardless of how the market is doing. This means that even if the stock market or other indexes that the annuity tracks do badly, your principal is safe and unaffected.
This allows investors to enjoy the gains that come with an index like the S&P 500 or the Russel 2000, as mentioned above, and not worry about the risk of loss. However, there is a downside to this that we will look at later on in this article.
Fixed Indexed Annuities are also preferred due to the tax savings that investors can avail of. Indeed, tax benefits are one of the key reasons that people choose FIAs, as you don’t have to pay taxes on the interest earned. You will only pay taxes when you choose to withdraw your money.
This means that the annuity grows tax-deferred, which is particularly helpful in building a good nest egg.
With an FIA, you also have the option of choosing an add-on to your base contract that can provide you with a lifetime income. This is known as a lifetime income rider and allows investors to receive a predictable source of money for retirement. This can be particularly helpful for those worries about outliving their savings. (Note: this option does come with additional fees)
What Are The Risks And Drawbacks Of Fixed Indexed Annuities?
While it appears that FIAs are a great investment option for retirement and offer a low-risk experience, they are not completely without risks. This is because FIAs are not FDIC insured and not backed by the government.
For this reason, it becomes extra important to do your research on the insurance company and ensure they are reputable and have a good track record. It can be helpful to get in contact with a consultant like Brian Anderson, owner of Annuity Straight Talk, a company that focuses on helping investors understand everything there is to know about this particular investment option.
You also want to look at the fine print and conditions before choosing to invest here. FIAs are known to have aspects that are not always ideal, such as limited liquidity and extra fees. However, the main con with FIAs is the low returns.
As with most investments, the risk-to-reward relationship is very much active here. The price that you pay for the low-risk and safety are the poorer returns when compared to more high-risk options. FIAs also come with a lot of fees, such as administrative and fund management fees, which all eat into your potential earnings.
Moreover, an integral part of FIAs is that the earnings are capped. What does this mean? Well, FIAs have an interest rate cap that can work against you if the invested-in indexes are doing well.
For example, if your particular annuity contract has an interest rate cap of 5%, then even if the indexes are earning 12% or 15%, you will not be receiving that bonus. Instead, you will be getting the capped interest of 5%.
This can be a big issue for some people so you want to be aware of interest caps when choosing where to invest. Of course, it can also work in your favor when the indexes do badly, as the insurance company will cover the loss. The low returns of annuities are also particularly concerning with regard to keeping up with inflation. There is a chance that your purchasing power decreases over time if inflation continues to rise, and this is one major con that investors need to consider when thinking about FIAs.
In conclusion, FIAs are very much a safe, low-risk option that can give you peace of mind and make for a good retirement income. You just need to be aware of the issues that the model is prone to have, such as lower returns and surrender fees. Using FIAs in conjunction with other investment options is highly recommended in order to have an avenue of high returns.