A Fixed Index Annuity (FIA) is an insurance contract that has tax-deferred, long-term savings protecting your principal in a down market while providing an opportunity for growth. To purchase an FIA, you can make a lump sum deposit, transfer over funds from a retirement plan, or make multiple payments over time. In most situations, when purchasing this type of annuity, you choose how the annuity company should invest the money. You can allocate the entire sum in one index or divide it across several. Your returns are then based on how the market indices you choose perform.
Most FIA’s provide options that include a return cap, participation rate, and/or a spread/margin/asset fee. These can become very confusing if you do not clearly understand what defines each feature.
A return cap is a set limit on your gains. If the index you chose has a 5% cap, you will receive 5% of the gains no matter how high the index gain is. For example, if the index rose 8%, you will receive 5%. This does not guarantee 5%. If the index gain is 3%, you will receive 3%. If the index experienced a loss, you gain nothing, but lose nothing, as well.
A participation rate is the percentage of index gain that you get to credit to your contract. For example, if the participation rate is 50%, you would receive half of the index gains for the contract year. If the market index return is 6%, your balance will grow by 3%.
A spread/margin/asset fee is a deduction from your return each year. For example, if the fee is 3% and your return is 9%, your money would grow by 6%.
Always remember that you can never lose money by participating in available indices within a FIA. On average, if you look at a number of historical 10-year periods, you will normally have a few years of significant growth, a few years of expected growth, as well as a few years of zero gains.
Each year on your contract anniversary, you can reallocate your funds. We help our clients each year by observing how the index/indices you chose performed and analyze the index choices provided by the annuity company each year to make an informed choice for your reallocation. If you have an income rider on your contract, that will provide for a fixed gain each year and it is not as important to reallocate your funds, especially if you have started taking income.
FIA’s are considered a long-term investment and therefore have a surrender fee with a period that lasts between five to ten years after you purchase the contract. This restriction usually begins with a 9% fee the first year and decreases to 0% after ten years. Most FIA’s have a “free withdrawal” each year that accounts for about 10% of the contract value.
A Fixed Index Annuity is often part of the “safe” portion of a retirement portfolio, as opposed to being in the stock market which is considered a “risk” with your investments. The best comparison would be a bond fund. FIA’s often outperform bond funds over a long period, but that is a conversation for another article.