FIAs: An insurance product with the potential to earn interest.

 

  1. Create a stream of income.

When you purchase an annuity, you are signing a contract between you and an insurance carrier that will provide you with an agreed-upon income stream in exchange for a lump sum of money. Fixed annuities are appealing to retirees because they provide a predictable source of income, and the annuity’s guarantees are backed by the financial strength and claims-paying ability of the issuing insurer. Social Security does not count the income stream from an annuity as earnings—they do not lower your Social Security retirement benefits.1

 

  1. Growth potential.

While FIAs are not directly invested in the stock market, they offer potential interest growth based on the performance of a specified index, such as the S&P 500®. If the index has a positive return, the FIA policy is credited with interest at specified intervals based on the individual insurance contract terms.

 

  1. Principal protection from market downturns.

In 2008, many people lost a significant portion of their retirement savings as a result of stock market volatility. However, those with fixed indexed annuities were able to keep a portion of their retirement protected regardless of the market downturn.

The reason for this is that money used to purchase an annuity is not actually invested in the stock market. The stock, bond or commodity index serves as a benchmark only, and the policy pays interest based on a formula related to index performance. It’s also important to remember that while the policy is not affected by market performance, other factors, such as early withdrawals, may result in loss of principal and credited interest due to surrender charges.

 

  1. Income guarantee.

Annuities are designed to pay a monthly amount either immediately or in the future (called a deferred annuity). There are also policy riders that offer lifetime income, as well as the option of adding your spouse. Since the average 65-year-old couple today has a 52% chance of having at least one spouse live to 95, based on the Annuity 2012 Generational Mortality Table2, FIAs with guaranteed lifetime income riders can be an attractive option to retirees who are worried about outliving their savings.

An income rider is an additional feature available with some annuities. It is generally optional and comes with additional costs. Income benefits are designed to provide options above and beyond the standard annuitization of free withdrawal features in annuities.

 

  1. Tax-deferred growth.

FIAs offer 100% tax-deferred interest growth. You’re not taxed on these earnings while your money stays in the annuity. Once you start receiving payouts, similar to a 401(k) or traditional IRA, they are taxed as ordinary income based on your income-tax rate at the time. Similarly, if payments begin before age 59-1/2, an additional 10% federal tax may apply. You can also hold FIAs in non-qualified accounts with similar tax benefits, although you will only be responsible for taxes on the interest earned when you take it out. As with qualified annuities, any distributions that you take prior to age 59-1/2 may also be subject to an addition 10% federal tax penalty.

Keep in mind, that for annuities issued after August of 1982, the IRS requires that distributions from annuities are made up of a return of interest first, then principal.

 

  1. More options.

Annuity policies continue to grow and evolve. There are FIAs that offer additional benefits and/or riders, often at an additional cost, such as inflation protection or coverage for long-term care. Each policy is different, and insurance companies offer varying coverage as they compete and evolve their policies and riders based on consumer demand.

 

  1. Predictable income can help make retirees feel more confident in their plan.

According to a Towers Watson Retirement Survey3, having predictable retirement income makes retirees happier than withdrawing money from investments like 401(k)s or IRAs to pay for retirement expenses, which can cause anxiety.

 

Common misconceptions about fixed indexed annuities.

 

  1. If you die early, you will lose your policy.

FIAs are insurance products that have changed and evolved, and many now allow spousal survivorship, as well as allowing you to name a beneficiary to receive a death benefit if you die early…without going through probate.

 

  1. You’ll lose access to your cash with no real guarantee you’ll see the benefit.

Most financial professionals suggest that their clients explore the option of including an FIA as part of a complete, balanced retirement strategy. With dramatic increases in longevity in the last decades, a lifetime income rider on an annuity can also be an option to consider. Some policies may even waive surrender charges for disability, unemployment or terminal illness.

 

  1. There are high commissions and fees.

Sales commissions on FIAs are paid by the insurance company offering the policy. Michael Kitces of Washington D.C., an industry expert who has analyzed the costs says, “Ultimately, the reality is that the expense of fixed and indexed annuities is actually remarkably similar to most other types of annuity and investment products.”4 As with other financial products, annuities may be subject to surrender charges and holding periods.

 

Sources:

1 Social Security “Frequently Asked Questions.” SSA.gov. https://faq.ssa.gov/link/portal/34011/34019/Article/3742/Will-withdrawals-from-my-individual-retirement-account-affect-my-Social-Security-benefits (accessed May 26, 2017).

2 American Society of Actuaries “2012 Individual Annuity Reserving Table.” Actuary.org. http://www.actuary.org/pdf/naic/Payout_Annuity_Report_092811.pdf (accessed May 26, 2017).

3 Willis Towers Watson “Annuities and Retirement Happiness.” Towerswatson.com. https://www.towerswatson.com/en-US/Insights/Newsletters/Americas/insider/2012/Annuities-and-Retirement-Happiness (accessed May 26, 2017).

4 Nerd’s Eye View, “The Myth Of “Free” No-Expense Fixed Or Equity Indexed Annuities – Interest Rate Spread Is Still A Cost!” Kitces.com. https://www.kitces.com/blog/the-myth-of-free-no-expense-fixed-or-equity-indexed-annuities-interest-rate-spread-is-still-a-cost/ (accessed May 26, 2017).

 

Shurwest is an independent distribution company based in Scottsdale, AZ. With transparency and accountability we empower our advisors by delivering industry-leading, consumer-focused retirement strategies that use a variety of investment and insurance products while providing cutting-edge education, marketing and practice management support.