If you are getting close to retirement, you may have heard someone mention a fixed indexed annuity.
Maybe a friend owns one.
Maybe you saw an advertisement promising protection from market losses.
Or perhaps you are simply looking for a way to create dependable retirement income without keeping all of your money exposed to stock market ups and downs.
Fixed indexed annuities can be useful retirement tools for the right person.
But they are not perfect. No financial tool is.
And they are definitely not right for everyone.
Before you move part of your retirement savings into any annuity, you should understand both sides of the story.
In this guide, we will look at the pros and cons of fixed indexed annuities, what they can do, what they cannot do, and some important questions to ask before buying one.
If you are brand new to annuities, you may want to start with this guide, What Is a Fixed Indexed Annuity? A Simple Guide to Retirement Income in Arizona.
What Is a Fixed Indexed Annuity?
A fixed indexed annuity, often called an FIA, is a contract between you and an insurance company.
You place money into the annuity, and the insurance company may credit interest based partly on the performance of a market index, such as the S&P 500.
But there is one very important distinction:
Your money is not directly invested in the stock market.
You do not own the stocks in the index.
Instead, the insurance company uses the movement of the index as part of a formula for determining how much interest may be credited to your contract.
A fixed indexed annuity may also offer options for creating income that can last for the rest of your life.
You can learn more about the different types of annuities available on our Annuities in Surprise, Arizona page.
PRO: Protection From Direct Stock Market Losses
This is probably the biggest reason people consider fixed indexed annuities.
If the stock market falls sharply, money directly invested in stocks loses value.Most people agree that the older we get the less comfortable we feel with losing money since we have less time and usually less opportunity to make that money back.
A traditional fixed indexed annuity works differently.
If the index used by your annuity goes down during a crediting period, you generally do not lose contract value simply because the index declined.
Instead, the indexed interest credited for that period may be zero.
That may not sound exciting.
But during a major market downturn, zero feels a lot better than minus 20%.
This may be especially important when you are already retired.
When you are 35 or 40, you may have many years to wait for the market to recover.
When you are 70 and withdrawing money each month to pay your bills, a large market decline can be much more difficult to manage.
Protecting part of your retirement money from direct market losses may therefore provide valuable peace of mind.
CON: You Do Not Receive All of the Market’s Gains
There is a tradeoff for that protection.
A fixed indexed annuity is not designed to give you the full return of the stock market.
If the S&P 500 has a very strong year, someone directly invested in the market will likely earn considerably more than someone whose money is in a fixed indexed annuity.
Insurance companies use different methods to determine how much interest is credited.
You may hear terms such as:
- Cap
- Participation rate
- Spread
- Index crediting method
For example, if an index rises 12%, that does not necessarily mean your annuity will earn 12%.
The contract may limit how much of that increase is used to calculate your interest.
So if your number-one goal is maximum long-term growth, an FIA may not be the best place for all of your money.
The value of the annuity is the tradeoff:
Less upside potential in exchange for protection from direct downside market losses.
PRO: You May Be Able to Create Lifetime Retirement Income
One of the biggest challenges in retirement is turning savings into a paycheck.
During your working years, you know another paycheck is coming.
Then retirement arrives.
Suddenly, instead of receiving a paycheck, you are responsible for deciding how much money to take out of your savings every month.
That creates a difficult question:
What if I live much longer than I planned?
Certain annuities offer options that can provide income for the rest of your life, depending on the contract and the income option selected.
That can create another dependable income source alongside:
Social Security + pension + annuity income
For someone worried about outliving retirement savings, having an income source designed to continue for life can be reassuring.
If this is one of your concerns, this Retirement Income Planner in Surprise page explains more about turning retirement assets into ongoing income.
CON: Your Money May Be Less Liquid
Fixed indexed annuities are designed to be long-term contracts.
Most have what is called a surrender period.
During that period, you may be allowed to withdraw a certain amount each year without a surrender charge, usually 10%. But if you take out more than the contract allows, a surrender charge may apply.
That means an annuity is generally not the place for money you may suddenly need next year.
For example, you probably would not want to put your entire emergency fund into an annuity if you knew you might need:
- A new roof
- A new vehicle
- Major dental work
- A large medical expense
- Money to help a family member
- Funds for an upcoming home purchase
Before buying an annuity, make sure you understand how much money you can access and what happens if you need more.
A good retirement plan usually includes liquid money that is easy to reach in addition to longer-term assets.
PRO: Tax-Deferred Growth
Another potential benefit of annuities is tax deferral.
With a nonqualified annuity, interest generally grows inside the contract without being taxed each year as it is credited.
Taxes are generally paid when taxable earnings are withdrawn.
That can allow money to remain in the contract without creating a yearly tax bill on the growth.
However, tax treatment depends on how the annuity is funded.
An annuity purchased inside an IRA, for example, does not create an additional layer of tax deferral because the IRA is already tax-deferred.
Tax rules can be complicated, so it is always wise to involve a qualified tax professional when tax planning is an important part of your decision.
CON: Annuities Can Be Complicated
Some fixed indexed annuities are fairly simple.
Others can feel like they come with their own dictionary.
You may encounter terms such as:
- Participation rate
- Cap
- Spread
- Point-to-point crediting
- Income base
- Benefit base
- Rider
- Roll-up rate
- Surrender schedule
You do not need to become an insurance expert.
But you should understand your own contract.
If someone is recommending an annuity to you, they should be able to explain it in plain English.
My rule is simple:
Do not buy something you do not understand.
If you find yourself thinking, “I hope this works the way he said it does,” you need more explanation before signing anything.
Kratos Financial FAQ page answers several common annuity and retirement-income questions in straightforward language.
PRO: It Can Help Reduce Retirement Market Anxiety
There is a difference between understanding market risk on paper and living through it in retirement.
Imagine you spent 40 years building your retirement account.
Now you have stopped working.
Suddenly the market drops sharply.
Even if you understand that markets historically move up and down, seeing your retirement account fall can be frightening.
Some retirees panic and sell investments at exactly the wrong time.
Using a fixed indexed annuity for part of a retirement strategy may help some people feel more comfortable because that portion of their money is not directly exposed to stock-market losses.
That does not mean avoiding investments entirely.
Instead, you can think of your retirement money as having different jobs.
Some money may need to:
Grow.
Some may need to:
Stay easy to access.
And some may need to:
Produce dependable income.
An annuity can be useful for that third job.
CON: Optional Riders May Have Costs
Some annuities offer optional benefits called riders.
A common example is a lifetime-income rider.
Depending on the contract, a rider may provide additional guarantees or income features.
But some riders have annual costs.
Those fees may reduce the contract value or affect the overall economics of the annuity.
Before purchasing an annuity with a rider, ask:
What exactly does this rider give me?
What does it cost each year?
Do I actually need it?
Never assume that more features automatically mean a better annuity.
PRO: It May Help Cover Essential Retirement Expenses
One useful way to approach retirement-income planning is to separate needs from wants.
Your essential expenses might include:
- Housing
- Utilities
- Groceries
- Insurance
- Healthcare
- Transportation
- Property taxes
Travel, entertainment, gifts and hobbies may be more flexible.
Some retirees like the idea of creating enough dependable income from Social Security, pensions and possibly an annuity to cover much of their essential monthly spending.
Then investment accounts may be used for more flexible expenses and long-term growth.
This approach can make retirement budgeting feel less uncertain.
You can learn more about how annuities fit into a broader strategy on this Retirement Planning in Phoenix, Arizona page.
CON: Guarantees Depend on the Insurance Company
Annuities are insurance products.
The guarantees are backed by the financial strength and claims-paying ability of the insurance company issuing the contract.
They are not the same thing as a bank account insured by the FDIC.
That means the financial strength of the insurance company matters.
Before purchasing an annuity, ask about the insurer’s financial ratings and understand who is standing behind the guarantees in the contract.
Choosing an annuity should involve more than comparing which company is currently advertising the highest rate.
PRO: An Independent Agent Can Compare Multiple Companies
Not every fixed indexed annuity is the same.
Different companies may offer different:
- Income benefits
- Crediting methods
- Surrender periods
- Participation rates
- Caps
- Riders
- Death-benefit features
- Financial-strength ratings
Working with an independent insurance professional can allow you to compare options from multiple carriers rather than being limited to one company’s products.
That does not mean one company will always be clearly “best.”
It means you can look for the contract that best matches the specific job you want the annuity to do.
For additional information, visit Annuities in Phoenix, Arizona .
Who May Be a Good Candidate for a Fixed Indexed Annuity?
A fixed indexed annuity may be worth considering if you:
- Are approaching or already in retirement
- Want to protect part of your savings from direct market losses
- Are concerned about outliving your money
- Want more predictable retirement income
- Have other liquid savings available
- Do not need immediate access to all of your retirement assets
- Prefer less market risk on part of your money
- Understand that you may give up some growth potential in exchange for protection
Who May NOT Be a Good Candidate?
A fixed indexed annuity may not be a good fit if you:
- Need access to all of your money at any time
- Have very little emergency savings
- Are primarily seeking maximum stock-market growth
- Are uncomfortable with surrender periods
- May need the money for a major near-term purchase
- Are being encouraged to put nearly all of your assets into one product without understanding why
An annuity should solve a specific retirement problem.
It should not be purchased simply because someone says it is “safe.”
Should You Put All of Your Retirement Money Into an Annuity?
For most people, retirement planning is not an all-or-nothing decision.
You may need several different types of assets.
Some money may stay invested for long-term growth.
Some may remain in savings for emergencies.
Some may be used for regular withdrawals.
And some may potentially be used to create guaranteed lifetime income.
The important question is not:
“Are annuities good or bad?”
A better question is:
“Would an annuity solve an important problem in my retirement plan?”
That is a very different conversation.
Questions to Ask Before Buying a Fixed Indexed Annuity
Before signing an annuity contract, make sure you can answer these questions:
How long is the surrender period?
How much can I withdraw each year without surrender charges?
How is interest calculated?
What is the current cap or participation rate?
Can those rates change?
Are there annual rider fees?
How does the lifetime income feature work?
What happens when I die?
What happens if I need a large amount of money unexpectedly?
What is guaranteed?
What is not guaranteed?
And finally:
Why does this particular annuity make sense for me?
If you cannot answer that last question clearly, you may need more information before making a decision.
Fixed Indexed Annuities for Arizona Retirees
For retirees and pre-retirees in Surprise, Phoenix, Sun City, Peoria, Glendale, Goodyear, Buckeye, Wickenburg, Wittmann and throughout Arizona’s West Valley, retirement may last 20, 25 or even 30 years or more.
Your retirement strategy has to do more than grow money.
It also needs to help you manage:
- Market risk
- Longevity
- Income needs
- Emergencies
- Inflation
- Healthcare expenses
- Your desired lifestyle
A fixed indexed annuity may help address some of those concerns.
But it should be considered as one tool within a larger retirement plan, not the entire plan itself.
So, Are Fixed Indexed Annuities Worth It?
The answer is:
For many people, yes. For others, no.
A fixed indexed annuity can offer protection from direct market losses, tax-deferred accumulation and the possibility of dependable lifetime income.
In exchange, you may give up some market growth potential and some liquidity.
That is the tradeoff.
The key is deciding whether that tradeoff helps you accomplish something important in your retirement.
At Kratos Financial & Insurance Solutions, Bonnie Clark helps retirees and pre-retirees understand annuity and retirement-income options in plain English.
The goal is not to start with a product.
It is to start with your retirement and your goals, not mine.
What income do you need?
How much risk are you comfortable taking?
How much money needs to remain liquid?
And what would help you feel confident that your retirement income can last?
If you are wondering whether a fixed indexed annuity would help or limit your retirement plan, schedule a conversation. We can look at your income needs, liquidity and goals before discussing whether an annuity belongs in the picture at all.