Yeah, annuities. If we call it the most complex investment out there it will not be completely false. A dazzling variety of these exist, but in what you are most likely to be interested in fixed or fixed-index annuity. Here we’ll discuss what exactly a fixed-index annuity is and how you can evaluate if a fixed-index annuity is right for your needs.
What is a fixed-index annuity?
We are happy you asked this important question—but before we explain a fixed-index annuity to you, we will first explain what an annuity even is.
As per financial advisor David Snavely, an annuity is a kind of insurance product that offers investors a stream of income. You need to pay some money upfront which is then invested and later paid out as per the pre-agreed amount and time frame during the “payout” period.
All annuities have mainly two components: the principal you pay and the returns you get on the same. Depending on the annuity type you set up, you can fund it with pre-tax (qualified annuities) or post-tax (non-qualified annuities) dollars. Whatever option you choose, the earnings or interest on an annuity grows tax-free until the money is withdrawn.
Types of annuities:
A fixed annuity is the simplest of them with the lowest risk and good growth potential. With these annuities, the insurance company takes money from you and makes it grow per the predetermined interest rate stated on the contract. This interest rate is typically higher than the national interest rate. After all, if they didn’t provide it, there’d be no reason to put your funds into an annuity instead of a bank.
In contrast, a variable annuity has the most risk among all types of annuity, Your funds are tied to the performance of financial markets. Your insurance company invests your money into various stocks, bonds, and mutual funds called sub accounts on your behalf. While you do enjoy the option of choosing the investments, you could lose all your money including your principal amount if they perform poorly.
An index annuity combines the elements of both of the above-mentioned annuities. Rather than investing directly in the stock market, your money is tied to the stock index as a whole: meaning the better the market performs, the higher your returns. A large benefit of this annuity is that you can only lose a small yet specified amount, as these products come with a floor reflected in your contract.
So, what is a fixed-index annuity, then? As you can derive from its name, this annuity combines features of both fixed and index annuities. David Alan Snavely explains that In these annuities, some of your money is invested in funds tied to one or more indexes while the rest is invested into a fixed-rate fund. You will typically enjoy the opportunity to choose the portion of your money that will be split between the two. These money-earning approaches are referred to as crediting strategies.
Are annuities a good investment?
Whether annuities are a sound investment depends on individual circumstances, as they may not be suitable for everyone. Annuities are designed to offer a consistent income stream, typically during retirement. They can be considered a prudent choice for individuals who fall into the following categories:
- Conservative investors seek a reliable source of guaranteed income for their lifetime.
- Concerned about the risk of running out of funds during retirement.
- Interested in safeguarding their legacy; including a death rider in the annuity allows the passing of assets to named beneficiaries without probate.
- Have maximized contributions to other retirement vehicles but still wish to continue funding their retirement.
If you identify with any of these criteria, it is advisable to further explore whether a fixed-index annuity aligns with your financial goals.
Investing is always finding the right balance between risk and reward, and fixed-index annuities are no different. However, as annuities are complex financial products available to investors, it’s important to speak with a financial advisor like David Snavely who can objectively evaluate if an annuity is right for you.