What Is a Fixed Indexed Annuity? A Simple Guide to Retirement Income in Arizona
Retirement should be a time to enjoy life—not a time to constantly worry about money.
But once the regular paycheck stops, a new question often comes up:
How do I make the money I’ve saved last for the rest of my life?
Maybe you have money in a 401(k), IRA, savings account or investments. You worked hard to build those accounts.
But saving money for retirement and creating income during retirement are two different things.
When you retire, you need money coming in every month to help pay the mortgage or rent, utilities, groceries, insurance, travel and all the other things that make up everyday life.
Social Security may cover part of those expenses. A pension may help if you are among the fortunate few who have one.
But what about the rest?
One option some retirees use is a fixed indexed annuity, often called an FIA.
The name sounds complicated.
The basic idea doesn’t have to be.
Let’s walk through it together.
What Is a Fixed Indexed Annuity?
A fixed indexed annuity is a contract with an insurance company.
You put money into the annuity, and the insurance company can credit interest to your account.
One of the features that makes a fixed indexed annuity different is that some of your interest can be based on how a market index performs.
A common example is the S&P 500.
But there is something very important to understand:
Your money is not actually invested in the stock market.
You are not buying stocks in the S&P 500.
Instead, the insurance company looks at what the index does and uses a formula to decide how much interest, if any, to credit to your annuity.
Why would someone want that?
Because a fixed indexed annuity may give you an opportunity to earn interest when the index rises without directly losing money because the stock market falls.
For someone nearing retirement, that combination can be attractive.
You can learn more about the different choices available on our annuities in Surprise, Arizona page.
How Does a Fixed Indexed Annuity Work?
Let’s use a simple example.
Imagine you place part of your retirement savings into a fixed indexed annuity.
The insurance company may give you several choices for how interest is credited.
You might choose:
- A fixed interest option
- An option tied to the S&P 500
- Another index offered by the insurance company
If the index goes up during the time period being measured, your annuity receives interest.
If the index goes down, you typically don’t lose money simply because the index fell.
Instead, your interest for that period could be 0%.
In other words:
You may not earn interest that year, but you don’t go backward because of the market decline.
There are still other reasons your contract value could be affected, such as withdrawals, fees or surrender charges, so it is important to understand your particular contract.
Do You Get All of the Stock Market’s Growth?
No—and this is important.
A fixed indexed annuity is not designed to give you all of the gains of the stock market.
In exchange for protection from direct market losses, the insurance company limits how much of an index’s increase is used to calculate your interest.
You may hear terms such as cap or participation rate.
They sound complicated, but they don’t have to be.
What Is a Cap?
A cap is simply a limit.
For example, imagine the index goes up 10%, but your annuity has a 7% cap.
Your credited interest would be limited to 7%, based on that simplified example.
You would not receive the full 10%.
What Is a Participation Rate?
A participation rate tells you how much of the index increase is used to calculate your interest.
For example, suppose the index rises 10% and the participation rate is 80%.
Eighty percent of 10% is 8%.
Other rules in the contract could affect the final amount credited, but that gives you the basic idea.
The important thing to remember is this:
You are giving up some of the potential market gains in exchange for protection from direct market losses.
That tradeoff may make sense for many retirees who are not comfortable with losing money at this stage of their lives and not for others.
What Happens if the Stock Market Goes Down?
This is one of the biggest reasons people become interested in fixed indexed annuities.
Let’s say the stock market has a terrible year.
If your retirement money is invested directly in the market, the value of those investments likely falls.
Money inside a traditional fixed indexed annuity generally does not lose value simply because the index it follows has gone down.
Your indexed interest for that period may be zero.
Zero may not sound exciting but sometimes zero might be your hero.
But during a major stock market decline, zero can feel pretty good compared with losing 10%, 20% or more.
This can become especially important when you are already retired and taking money out of your accounts.
When you are younger, you have many years to wait for the market to recover. Time is on your side.
When you’re retired, you may be withdrawing money at the same time the market is falling.
That can put much more pressure on your retirement savings.
A fixed indexed annuity can be one way to protect a portion of your money from that kind of direct market loss.
It is important to remember, though, that the guarantees of an annuity depend on the financial strength and claims-paying ability of the insurance company issuing it.
How Can a Fixed Indexed Annuity Create Retirement Income?
This is where annuities can become especially interesting for retirees.
Think about your working years.
Every week or every two weeks, a paycheck arrived.
You knew another one was coming.
Then retirement arrives—and suddenly you have a pile of savings instead of a paycheck.
Now you have to figure out:
How much can I safely take out every month?
That depends. And an even bigger question:
What if I live longer than I expect?
Many fixed indexed annuities can provide an option for income that can continue for the rest of your life, depending on the contract and income option chosen.
Think of it as creating your own personal retirement paycheck.
You may have Social Security coming in.
Maybe you have a pension, maybe not.
An annuity may provide another source of predictable income.
For example:
Social Security + pension + annuity income = dependable monthly income
Your investments can then serve other purposes, depending on your overall financial plan.
If you’d like to understand this concept in more detail, read How to Get a Guaranteed Retirement Paycheck for Life.
What if I Live to Be 95?
This is one of the hardest parts of retirement planning.
Nobody knows how long he or she will live.
Suppose you retire at 65.
Do you plan for your money to last until 80?
90?
95?
100?
You don’t want to spend too much too quickly and run out of money later.
But you also don’t want to be so afraid of running out that you don’t enjoy the retirement you worked hard for.
Financial professionals call this longevity risk.
That simply means:
The risk that you live longer than your money lasts. Longevity risk increases all other financial risks as well.
Lifetime income from an annuity can help address that concern because most annuity income options are designed to continue paying even if you live a very long life.
That doesn’t mean all of your money should go into an annuity.
It means an annuity may be one tool used to help create a more dependable retirement paycheck.
That’s an important part of retirement income planning in Phoenix, Arizona.
Is a Fixed Indexed Annuity Better Than the Stock Market?
It isn’t really an either-or question.
The stock market and a fixed indexed annuity have different jobs.
Investments in the stock market can provide greater opportunity for long-term growth.
But they can also lose value.
A fixed indexed annuity generally has less growth potential, but it can protect your money from direct losses caused by a falling index.
Think of your retirement money as having different jobs.
Some money may need to grow.
Some may need to stay easy to reach.
And some may need to help create dependable income.
An annuity may be appropriate for that third job.
The better question isn’t:
“Should I invest my money or buy an annuity?”
It may be:
“Which part of my money should stay invested, and which part needs more protection or dependable income?”
What Are the Benefits of a Fixed Indexed Annuity?
Here are some of the reasons retirees consider them.
Protection From Direct Market Losses
If the index falls, you generally don’t lose money just because the market went down.
That may provide peace of mind, especially after retirement.
Opportunity to Earn Interest
When the index rises, you receive interest based on the rules of your contract.
You won’t necessarily receive all of the market’s growth, but you have the opportunity to earn interest without being directly invested in the market.
Tax-Deferred Growth
With a nonqualified annuity, you generally don’t pay taxes each year as interest is credited.
Taxes are usually due when taxable earnings are withdrawn.
Different rules apply when an annuity is held inside an IRA or other retirement account such as a ROTH IRA, so your individual tax situation matters.
Lifetime Income
Certain annuities can create income designed to continue for the rest of your life.
For someone worried about running out of money, that can be valuable.
More Predictable Retirement Income
Many retirees simply want to know:
“How much money will I have coming in each month?”
Predictable income can make budgeting easier and reduce the need to sell investments during a bad market.
You can learn more about these options at this annuities in Phoenix, Arizona page.
What Are the Downsides of a Fixed Indexed Annuity?
There are downsides, and you should understand them before buying one.
Your Money May Be Tied Up for Several Years
Annuities are meant to be long-term products.
Most have a surrender period.
That means if you take out more than the contract allows during the early years, you may have to pay a surrender charge.
For that reason, you generally don’t want to put money into an annuity that you may need next year for a new roof, medical expense or other large purchase.
You Won’t Receive All of the Market’s Gains
Remember our tradeoff?
You receive protection from direct market losses, but you also give up some potential growth.
If the stock market has a fantastic year, someone directly invested in the market will likel oy earn considerably more than someone whose money is in a fixed indexed annuity.
Some Annuities Can Be Complicated
Annuities can include different indexes, riders, participation rates, caps and income calculations.
My rule is simple:
Don’t buy something you don’t understand.
A financial professional should be able to explain the annuity to you in plain English.
If you still don’t understand how it works, keep asking questions.
Some Optional Benefits Cost Money
Certain annuities offer optional riders, including lifetime-income features or guaranteed roll up rates.
Some riders have annual charges.
Make sure you understand what you are paying for and why you need it.
Who Might Consider a Fixed Indexed Annuity?
A fixed indexed annuity may be worth exploring if you:
- Are approaching or already in retirement
- Are nervous about losing part of your retirement savings in a market downturn
- Want dependable retirement income
- Worry about outliving your money (don’t worry, you are not alone. Outliving your money is the number one financial concern among seniors.)
- Have savings you won’t need immediately
- Want some opportunity for interest without directly investing that money in the stock market
- Already have money set aside for emergencies
On the other hand, an annuity may not be a good fit if you need easy access to all of your money or if your main goal is getting the highest possible long-term market growth.
Should I Put All My Retirement Money Into an Annuity?
Usually, this isn’t an all-or-nothing decision.
Your retirement money may need to do several jobs.
You need money for emergencies.
You may want investments for future growth.
You may want money available for travel, a new vehicle or helping family.
And you need money to pay your regular monthly bills.
The goal is to decide whether part of your retirement savings should be used to create dependable income.
Before deciding, look at your whole financial picture:
- Social Security
- Pension income
- Monthly expenses
- Emergency savings
- Investments
- IRAs and 401(k)s
- Healthcare costs
- Debts
- Travel and lifestyle plans
- Money you’d like to leave to your family
This Retirement Income Planner in Surprise, Arizona page explains more about planning for the income you’ll actually need after you stop working.
Questions to Ask Before Buying a Fixed Indexed Annuity
You don’t have to become an annuity expert.
But you should know the answers to a few important questions:
How long will my money be tied up?
How much can I withdraw each year without a surrender charge?
How is my interest calculated?
What fees or rider charges will I pay?
Can the cap or participation rate change?
How does the lifetime income work?
What happens to the money when I die?
What happens if I need a large amount of money unexpectedly?
Which parts of the contract are guaranteed?
And perhaps the most important question:
Why does this annuity make sense for my retirement plan?
The answer should be easy for you to understand.
You can find answers to more common questions on the Kratos Financial FAQ page.
Fixed Indexed Annuities for Arizona Retirees
Here in Arizona, many people retire to Surprise, Sun City, Peoria, Goodyear, Buckeye, Glendale and the greater Phoenix area because it is a wonderful place to enjoy retirement. We are happy we don’t have to worry about driving on ice or shoveling snow and one of my favorites, we can garden year round.
Our retirements may last a very long time.
The goal isn’t simply to reach retirement with a certain amount of money.
The goal is to make that money support the life you want to live.
That may mean keeping some money invested for growth.
It may mean keeping enough cash available for emergencies.
And it may mean using part of your savings to create income you can depend on.
A fixed indexed annuity is one tool that may help accomplish that.
Is a Fixed Indexed Annuity Right for You?
There is no annuity that is right for everyone.
And not everyone needs one.
A fixed indexed annuity may help you protect part of your retirement savings from direct market losses while giving you an opportunity to earn interest and, depending on the contract, create income that can continue for life.
But there are tradeoffs.
You will likely give up some growth potential over time.
Your money may be less liquid.
And you need to understand the contract before you buy it.
That’s why the conversation should never start with:
“Which annuity should I buy?”
It should start with:
“What do I need my retirement money to do for me?”
At Kratos Financial & Insurance Solutions, Bonnie Clark helps individuals and families in Surprise, Phoenix and throughout Arizona’s West Valley understand their retirement income choices in plain English.
You don’t need to understand every financial term.
You simply need to understand your money, your choices and how they affect your future.
And before your working paycheck stops, it is a good idea to know where your retirement paycheck will come from.
Reach out to schedule your discovery call today!