by Everyone wants a safety net to spend the later years of their life comfortably! In this regard, they may have various investment options to consider.
If you, too, are looking for a low risk means of earning a reasonable return on investment without the risks associated with market volatility, consider fixed index annuities. These are a form of index annuity, where your income is tied to a stock market index, but you still have a safety guarantee. Interested in learning more? Read this brief but helpful guide to find out what fixed index annuities are and how they can benefit you!
What are fixed index annuities?
Unlike a conventional fixed annuity, where you get a fixed rate of return, a fixed index annuity offers a return on your investment based on the performance of a stock market like NASDAQ, S&P 500, etc. Hence, with a fixed index annuity, you get to benefit from the upside in the market without exposing yourself to the market risk.
Fixed index annuities have become quite popular in recent years as many investors seek options that offer them returns but also safeguard them from the risks associated with market volatility or unpredictability.
Hence, if you want to earn a return on your investment but cannot risk losing your principal amount, a fixed index annuity may be a viable choice for you. It is, however, important to note that while there is potential to earn and risk is low, you may not know how much you will earn.
Key elements of fixed index annuities
Most fixed index annuities are a form of deferred annuity. It implies that there is a certain accumulation period in which your principal grows, for which you are required to make periodic premium payments. Hence, when buying the contract for a fixed index annuity, you can structure your accumulation period according to what suits you.
Some policies also come with a minimum guaranteed value- which means that a certain interest is credited to your account regardless of how the index performs. This is also referred to as a floor.
Your insurer will also set a participation rate, which determines how much of the index’s return will be credited to you. Here is an example to explain this! If your participation rate is set at 75% and your selected index performs at 10%, your annuity is credited with 7.5% interest.
Another element of a fixed index annuity is caps. While floors limit your loss, caps limit your earnings. This is your insurer’s protection against the index risk in exchange for the protection they offer you against market downsides. For instance, if your selected index performs at 10%, but your cap is set at 8%, your annuity will be credited with an interest of 8%.
Insurers also buffer against prospective losses via administration and commission fees, which are all determined beforehand and outlined in the contract.
Fixed index annuities also come with a surrender period, which is intended to discourage investors from taking money out of their accounts before a certain period. So, if your surrender period is set at 5 or 10 years and you want to withdraw from your account before this period, you will have to pay a certain penalty fee.
The advantages of opting for a fixed index annuity
One of the primary benefits of a fixed index annuity is tax deferral. It implies that you are not required to pay income tax until you choose to withdraw your annuity. This is one major advantage that fixed index annuities have over certificates of deposits or mutual funds.
Another obvious benefit of a fixed index annuity is the protection. Your principal amount remains intact while you get protection against inflation, which can be a significant safety net for the future. Similarly, the floor or minimum guarantee is designed to limit your loss, so you can expect to earn a certain interest regardless of how your index performs.
Deciding if investing in fixed index annuity is right for you
If you want an income stream that is protected from market volatility and gives a reasonable return on investment, a fixed index annuity is the ideal choice.
The best fixed index annuity for you will depend on your risk tolerance as well as how much return on investment you expect to generate. It is also important to understand that a fixed index annuity is not a liquid investment.
If you choose to withdraw your annuity before the surrender period is over, you will have to pay the penalty. If you have not acquired many retirement assets yet, it may not be the best time to invest in a fixed index annuity. It is important to have a cash reserve in hand or an asset that can be liquidated quickly before you buy a fixed index annuity.
It is, hence important to carefully evaluate your options before making an investment decision.
Conclusion
If you want to supplement your income stream in the later years of your life, a fixed index annuity may be exactly what you need. Also, if you are a keen investor who wants to add a low-risk investment to your portfolio, consider buying a fixed index annuity.
Since these annuities take time to deliver, it is important to plan carefully and consider how many years you have till retirement. Also, consider your investment objectives and how much risk you are willing to tolerate. It may also be helpful to consult a financial advisor to assess which option is best suited for your needs.
