For all investors, growing and protecting savings without the risk of market volatility or the risk of losing any of their savings sounds like a dream. But, with fixed indexed annuities, this is exactly the case.
An indexed annuity is a special type of annuity that yields returns on investments that are based on a specific equity-based index. These types of annuities offer the opportunity to earn higher yields based on how well the stock market does, but with protection when the market declines. It is not uncommon for yields on indexed annuities to be lower than other types of investments, but when other investments lose money and value, an indexed annuity does not.
Stock Market-Based Yields
There is not a set interest rate on an indexed annuity. It is calculated as a percentage of gain from the S&P 500 Index. There are two ways the actual percentage is calculated. The first is the year-over-year (YOY) gain from one year to the next. The second is the average monthly gain over a 12-month period of time.
Capturing and Capping Market Yields
In a good year, the stock index will realize a gain. A portion of this gain is then credited to the indexed annuity account based on the percentage of participation rate decided by the insurer. Most percentages range from 25% to 100%, but most indexed annuities offer ranges from 80% to 90% annually in the first few years, then adjusts the rate downward in subsequent years.
For example, if an investor is at an 80% participation rate and the stock index gains 15% for the year, the credited yield is 12%. However, most indexed annuities have a cap or limit to the percentage of yield no matter how much the stock index gains. These can vary from annuity to annuity, so check cap percentages carefully.
Although not privy to exceptional market gains from caps, there is also protection from a declining stock market. When the market has a negative return for the year, owners of indexed annuities still receive a guaranteed credit that can range from 0% to 3%. But, they are assured that there will not be a loss that year.
Protection of Gains
At certain times, the insurer of the indexed annuity will adjust the account upward to reflect any gains that have been incurred. This means that the new principal amount, that can never decline, goes up and more money is protected from loss. A YOY reset or a point-to-point reset are often used when readjusting the principal amount.
Losses Over Time
The stock market had a volatile history from 2000 to 2008.
- 1999 – investors are pleased with the steady increase in the stock market
- 2000 – The Standard and Poors Stock Index (S&P 500) lost 9.11% in value
- 2001 – Another yearly loss on the S&P 500 of 11.98%
- 2002 – The most devastating of the 3 years of loss with a 22.27% drop in the S&P 500
- 2008 – The greatest stock market loss since the 1929 crash, the market dropped 37.22%
This meant that investing $1.00 in the stock market at the beginning of 1999 meant that at the close of 2008, that $1.00 investment was not worth $0.86, a decrease of 15% in ten years. Ironically, those who put their money in their mattress actually realized a greater return that investors.
If the stock market loses 40% in one year again, as it did in 2008, it would take 5 years of gains higher than 10% just to break even again. This is why with retirement investments, avoiding a volatile stock market can mean the difference in a cozy retirement or ruin. Protecting a retirement nest egg against loss should be the main concern for anyone considering retirement in the next 10 years.
Fixed Indexed Annuity
Other than a pension and Social Security, there are not many options for a guaranteed income stream during retirement. Many retirees are concerned with outliving their retirement savings. However, with a fixed indexed annuity, they have the opportunity to have a guaranteed lifetime income, even if they take more than the annuity cost. This can bring relief and decrease fears for many seniors.
A fixed indexed annuity is one of three different types of annuities: fixed, variable, and indexed annuities all provide a steady stream of income during retirement, but the risk taken on each is different.
- Fixed annuity – a fixed rate of interest is paid over the term of the contract
- Variable annuity – the owner’s money is invested in mutual fund subaccounts that can go up or down in price
- Indexed annuities – similar to fixed annuities, but instead of a fixed amount paid over time, indexed annuities credit the owner with interest based on the performance of an underlying financial benchmark index such as the S&P 500
Each has its own pros and cons and anyone considering purchasing an annuity should seek the advice of a qualified professional financial planner.
In addition to the different types of annuity plans available, there are also different types of payouts offered: straight life, joint life, or a straight or joint life option with a certain period for payout.
If security is the main objective of purchasing an annuity, then finding one with a greater guarantee will mean a lower payout. This means that after an annuity is purchased, a definite income stream is guaranteed and a client cannot turn around and cancel the deal. One should think long and hard about retirement goals and what exactly an annuity would do for them.
If a person is inclined to purchase a certificate of deposit (CD) from a bank, then an annuity is probably the better choice for them. With historically low-interest rates, CD’s have not been gaining much in the way of interest. Many new indexed products today offer many attractive features that should be explored.
Since fixed indexed annuities can provide a peace of mind during retirement, investors should study all of the different nuances before deciding on which annuity to purchase.