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FIA facts: 10 fixed index annuities truths

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Annuities offer an array of benefits to those nearing or planning for retirement. The biggest advantages is that annuities are an investment vehicle that serves as a complement to other retirement income sources such as Social Security and pension plans, that enable individuals to save a larger amount of cash and defer paying taxes.

And unlike other tax-deferred retirement accounts such 401(k) s and IRAs, annuities do not have an annual contribution limit. All invested money compounds year after year. When an individual wants to cash out of an annuity, he or she can withdraw a lump sum or withdraw in the form of payments for a specific period of time, providing a steady and reliable income stream.

Each type of annuity, deferred and immediate, fixed or variable, offers its own array of benefits. However, a fixed indexed annuity (FIA), which is essentially a contract between an individual and an insurer, offers distinctive benefits that include indexed interest potential, optional benefits and tax deferral.

Despite their unique, positive attributes, FIAs still remain a bit of a mystery to some. David. F. Babbel, professor of insurance and finance at The Wharton School at the University of Pennsylvania, presented the research from a team of Ph.D. economists and two senior actuaries, regarding facts about FIAs and why they’re a great component in individual retirement plans in report based on a two-year in depth study of fixed indexed annuities.

Here is what the study found:

1. Annuities of all types are wise investments and FIAs are no exception. In a separate study, Investing Your Lump Sum in Retirement, Babbel notes that “the list of positive attributes of annuities, i.e. guaranteed payments you cannot outlive, access to investment capital and legacy benefits, the argument for this income solution in retirement is compelling.”

2. Earnings from a fixed indexed annuity are tied to an external market index like the Standard & Poor’s 500 and provide upside potential, but protect individuals from downside risks inherent in stock market involvement. 

3. FIAs are great performers. Many FIAs have outperformed any combination of corporate and government bonds, equity mutual funds and money markets since their inception in 1995, when they were developed as an alternative to mutual funds. 

4. While FIAs do not have the dramatic potential for upside gain as stock market investment, they’re also protected from loss – and can actually earn well. “Moderate returns that never experience a loss can outperform the stock market over time,” Babbel stated.

5. FIAs have an annual reset feature that automatically resets the annuity’s index value at the end of each contract year. This feature ensures that the current year’s ending value will become the next year’s starting value, and it includes in the value the interest the contract earned during the year. “There’s tremendous power in annual reset.” However, if an individual doesn’t capture the gains, he or she will likely lose them, Babbel said.

6. FIAs provide income an individual can’t outlive. And an FIA grows at a guaranteed rate during deferral; the payout is determined by age and value in the income account; the payout continues for life, regardless if the accumulation value is depleted; an individual maintains control of the accumulation value; and finally, an FIA can come with low or no fees.

7. According to the Financial Industry Regulatory Association (FINRA), the index-linked interest rate computed on an FIA depends on the particular combination of indexing features that the annuity uses. These include:

  • Participation rates, which determine how much of the gain in the index will be credited to the annuity;
  • The spread/margin/asset fee that some FIAs use in addition to or instead of a participation rate. This percentage will be subtracted from any gain in the index lined to the annuity;
  • Interest rate caps put on an individual’s return. The cap rate is typically stated as a percentage.

8. According to the National Association for Fixes Annuities (NAFA), individuals buy into fixed indexed annuities for a number of reasons, including saving money for retirement, saving money for business partners, loved ones or charities at death, and saving for planned and unplanned expenses.

9. As with all types of annuities, guarantees are backed by the financial strength and claims paying ability of the insurance company.

10. Those who have annuities generally think they’re a good deal. According to the 2013 Survey of Owners of Individual Annuity Contracts, conducted by The Gallup Organization and Mathew Greenwald and Associates for the Committee of Annuity Insurers, 9 out of ten annuity owners believe that annuities are an effective way to save for retirement.

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