Fixed Index Annuities
We have a love/hate relationship with Fixed Index Annuities. We used to love them, then we began to hate them, and now we’re swing back towards love…in the right situations. Most Fixed Index Annuities aren’t right for everyone, but for the right person, they can be an excellent part of your planning strategy! (We’re continuing the annuity topic we started here.)
So let’s explain how they work, and then give you a little history and finally let you know why we’ve gotten so excited about them recently…
How Fixed Index Annuities Work
First of all, you should know that, your principal is guaranteed. There are typically anywhere from two to several options for how your money earns interest within a Fixed Index Annuity (FIA). You’ll typically have a fixed rate option. This will move up and down as the interest rate market changes, but will also usually have a guaranteed floor.
You’ll also have index options. These are options that credit your account if certain markets move in certain ways. For instance, if your option is tied to the S&P 500 then if that Stock market index goes up, you will be credited with a gain. If that market goes down, you will not lose anything because you were not actually in the market. So this is a way to participate in stock market gains without incurring losses.
Of course there is a price to pay for this utopian world. You don’t receive all the gains.
Your gains will be subject to either a Cap, Spread, or Participation Rate.
Caps – A cap sets the limit to the amount that you can gain when the index gains. Thus, if you have a 5% cap, you can make up to 5%. If the index you’re tied to goes up more than 5%, you will receive 5%. If it goes up between 0 & 5%, you will receive what the index gains. If the index goes down, you will not see a change in your principal.
Spread – A Spread allows you greater upside in the gains of an index, but takes the first X% of that gain before you can be credited any interest. Thus, if there is a 5% spread, you will not receive anything if the index losses any amount or gains anything less than 5%. If the index gains some amount of 5%, you will get the difference between what it gained and the spread of 5%.
Participation Rate – A participation rate gives you a percentage of the indexes gains. Thus, if you have a participation rate of 30%, you will get 30% of whatever positive gain the index gets. Again, you won’t get anything if the index is down because you never participate in market losses within a FIA.
The Index options get a lot more complicated with annual, multi-year, & monthly options. As well as other types of Index offerings such as Inverse Market options and Interest Rate Benchmark options. Some of these options are pretty exciting to think through, but we don’t want to over complicate this basic education any more than we have. You must consider the particular attributes of any FIA’s you are considering. Of the above, the Cap will typically do better in years that the market has small gains while the Spread or Participation Rate will typically do better in years with large market gains. Caps are the most common type.
Now that we’ve confused you, let’s give a bit of the history of these products before we get to the add on feature that gets us really excited about this product for a lot of our clients.
On Friday, we’ll get deeper into both the history of this type of product and on what is offered in the market today…
This is the 8th post in our series of innovative new insurance products. You can find the previous posts at: 1) Innovative Insurance, 2) Long Term Care, 3) Long Term Care Solutions, 4) Free Long Term Care Insurance, 5) What is an Annuity?, 6) Immediate Annuities, & 7) Fixed & Variable Annuities.