The Fixed Index Annuity: Recession-Proof Your 401k and IRA

Shawn Plummer

CEO, The Annuity Expert

Did you know that a type of retirement investment is immune to stock market crashes and recessions? It’s called the fixed index annuity, and it could be the answer to your prayers during these uncertain times. This guide will discuss what a fixed index annuity is, how it works, and why it might be a good option for you.

What is a Fixed Index Annuity?

A fixed indexed annuity (FIA) is a type of annuity that provides a guaranteed interest rate and the potential for growth based on the performance of an underlying index. This investment strategy can be an excellent option for those looking to protect their retirement savings from market volatility to secure their financial future.

How does a Fixed Index Annuity Work?

A Fixed Indexed Annuity is a type of fixed annuity that allows a consumer to earn interest based on the performance of a stock market index such as the S&P 500, Dow Jones, and Nasdaq. This insurance-based, tax-deferred retirement plan means fixed index annuity owners can’t lose money due to stock market volatility and downturn.

You can only lose your retirement savings to fees and spending down the account.

Fixed index annuities (equity-indexed) are considered insurance-based, tax-deferred accumulation retirement savings plans. They are not investment products. Investment annuities are called variable annuities. Unlike variable annuities, you can not lose money to stock or bond market volatility.

Other names for an FIA are:

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The Accumulation Phase

Fixed index annuities help protect your retirement income from risks like stock market exposure and outliving your money. An indexed annuity does this through benefits that shield your money from market downturns while allowing growth opportunities to earn interest. These interest credits are tied to increases in a popular index, such as the S&P 500.

A fixed index annuity is designed to protect and grow your retirement savings to build up assets for the future or provide a guaranteed income later in retirement.

The Income Phase

The income phase is an optional phase with a fixed index annuity. If you choose to utilize the income option, the money that has been credited to your contract can be turned into an income stream that can last a lifetime. The income can be generated through annuitization or a fixed indexed annuity with a guaranteed income rider.

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Who Are Fixed Indexed Annuities Designed For?

  • Moderate and conservative investors want safe stock market growth for their 401(k) or IRA with added protection from a stock market crash.
  • Consumers want to guarantee a future fixed income starting today.
  • Investors want to receive regular income in retirement for as long as they live.
  • New retirees want their savings to continue to grow while providing regular income.
  • Investors want to lock in their interest so they can leave money to their heirs.
  • Pre-retirees who have maxed out their 401(k) and IRA want to save even more with tax deferral.

Fixed Index Annuity Pros and Cons

Protection from Market Volatility

A fixed index annuity allows you to participate in positive market performance and lock in gains. In addition, the account value is protected, even when the market declines.

Tax-Deferred Growth

Owners don’t pay ordinary income tax on earnings annually like a certificate of deposit (CD). Instead, fixed deferred annuities offer tax deferral, which means you can earn interest on your initial investment, earned interest, and the money that usually would go to the IRS. This compounding effect is called triple compounding. Income taxes are owed on the earnings withdrawn from the fixed index annuity each year.

Triple Compounding Interest

Some annuities pay simple interest during an index term. That means index-linked interest is added to your original premium amount but does not compound during the term. Others pay compound interest during a term, which means that index-linked interest has already been credited and earns future interest. In either case, however, the interest earned in one term is usually compounded in the next.

You need to know whether your annuity pays compound or simple interest during a term. While you may earn less from an annuity that pays simple interest, it may have other features you want, such as a higher participation rate.

Cheaper Than Variable Annuities

Expect to pay anywhere from 0% to 1.5% of the Account Value in fees annually with a fixed index annuity.

Lock-In Your Gains

Every time you earn interest on any given anniversary, you lock in the gains you’ve received. Those gains can not be lost due to a downturn in market volatility like variable annuities. You can never go backward (lose money) in contract value outside a withdrawal, surrender charge, or fee. This method of earning interest is called The Annual Reset Method.

The Income Rider

The income rider distributes a flexible yet fixed retirement income stream that retirees can’t outlive. The income rider is also known as a Guaranteed Lifetime Withdrawal Benefit (GLWB). Use our annuity calculator to get a quote.

Accelerating Your Retirement Savings

Unlike 401(k)s and IRAs, indexed annuities have no contribution limits for non-qualified premiums. This may appeal to older consumers looking to boost retirement savings or those who have maxed out annual 401(k) and IRA contributions.

Longevity Protection

A fixed index annuity can include an income rider for an additional fee or free. The rider can generate guaranteed income that can last a lifetime.

Tax Advantages

Unlike withdrawals from 401(k)s and IRAs, which are fully taxable (except Roth IRAs), clients only pay taxes on the interest earned in their fixed indexed annuities for non-qualified premiums. In addition, because the income is typically made up of a combination of interest earned and your original premium, only a portion of the payment is taxable. This ratio can help you use the annuity income in conjunction with fully taxable withdrawals from other retirement plans to lower your overall tax burden in retirement.

Long Term Contracts

Fixed index annuity contracts can range from 3 years to 16 years in length. However, the standard length with most annuity companies tends to be a 10-year indexed annuity contract.

Limited Growth

Typically a fixed index owner should earn better than a traditional fixed annuity but nowhere near a variable annuity. So if you’re looking for all the upside potential in growth, check out variable annuities.

How does a Fixed Index Annuity help a Pre-Retiree?

Suppose you’re approaching the last step in your career and want to scale back in risk tolerance. In that case, a fixed index annuity might be an excellent way to grow your assets since you get to participate in a portion of the upside potential but protect from all the downside of a market downturn.

Suppose you’re looking to convert your retirement savings into a pension income solution. In that case, many annuity products with lifetime income riders will tell you today what your annuity income payments would be in 5, 10, 15, or 20 years. This predetermination could be a good foundation for your fixed retirement income planning, especially if you want to meet goals for retirement.

Key Takeaway

Because fixed index annuities offer guaranteed income riders, a pre-retiree can create a retirement roadmap and solve how much money needs to be saved going forward, starting today, to achieve their desired retirement income in the future, up to 30 years in advance.

How does an Indexed Annuity help a Retiree?

Who does not benefit from an Index Annuity?

  • A consumer seeking aggressive growth with all the upside.
  • An investor seeking short-term commitments.
  • Someone wanting unlimited liquidity.

Fixed Annuity Vs. Fixed Index Annuity

How does an indexed annuity differ from a fixed annuity? A fixed index annuity is different from fixed annuities or MYGAs because of the way it credits interest to the annuity’s value. A fixed annuity only credits interest at a fixed rate. A fixed index annuity credits interest either by a fixed interest rate, the positive performance of an external index, or both.

Fixed index annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest is calculated and credited. How much additional interest you get and when you get it depends on the features of your particular annuity.

Like other fixed annuities, your fixed index annuity also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate, even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum.

For example, many single premium contracts guarantee that the minimum value will never be less than 87.5% of the premium paid, plus at least 1-3% in annual interest (less any partial withdrawals).

The guaranteed value is the minimum amount available during a term for withdrawals and some annuitization and death benefits. In addition, the life insurance company will adjust the value of the fixed index annuity at the end of each term to reflect any index increases.

Fixed Index Annuity Vs. Variable Annuity

The critical difference between a fixed index and variable annuities is the upside potential and the market volatility protection. The variable annuity’s strength is the ability to make 100% of the upside potential from a subaccount which is excellent. However, the variable annuity’s downfall is the ability to lose 100% of the money from market volatility, which is the fixed index annuity’s strength.

The investment annuity does not offer an annual reset feature for accumulation like the fixed index annuity.

In perspective, variable annuities would need a return greater than both the loss and the fees combined to get back to the investment’s original value. For example, if the variable annuity had a 10% loss one year and the 4% annual fee, the variable annuity would need a 14% return to break even and a 15% return to fully recover the following year.

Now imagine if the variable annuity’s losses continued to increase in a downturn, the time to recover would be even longer. When comparing a variable annuity with a fixed index annuity, compare the upside potential and the amount of time to recover from potential losses.

Fixed Index Annuities Vs. Mutual Funds

Mutual Funds

Mutual funds are investment products whose value fluctuates based on the underlying securities. When investing in an individual stock through a mutual fund, the value of your share is tied directly to the combined returns of all of the fund’s underlying securities. Thus, an investor fully participates in both the gains and losses of the investment. Share can be bought and sold daily, with some limitations.

Fixed Index Annuities

Fixed index annuities earn interest based on the upward performance of a market index but are not stock market investments nor participate in any investments. Gains are limited by a cap, spread, or participation rate. The interest earned is locked in each reset period. Thus, fixed index annuities protect from stock market loss. Index annuities are long-term savings products with limited liquidity.

Features and Definitions

Fixed Indexed Annuities have various features to offer to both pre-retirees and retirees. The following describes fixed index annuity features that may be in your contract.

The Indexing Method.

The indexing method is used to measure the amount of change in the index. Some of the most common indexing methods include point-to-point, averaging, and declared fixed interest, utilizing the annual reset method.

Locking In Your Gains.

The interest earned from a fixed index annuity is “locked in” at the end of a reset period, and previous gains are protected from loss.

Any future decreases in the index will not affect the interest you have already earned up to that point in time. In addition, locking in your gains means a down market does not impact your accounts, so you’ll never have to recover from negative returns.

Using the annual reset method, your fixed index annuity may credit more interest than annuities using other ways when the index fluctuates up and down often during the term. This design is more likely than others to give you access to index-linked interest before the term ends.

Liquidity

Despite popular belief, the current fixed index annuity contract typically offers several ways to access funds inside your retirement account.

  • Penalty-Free Withdrawals: The allotted amount or percentage of funds an owner can withdraw every year.
  • Waiver of Premium: An annuity company may offer a benefit to waive surrender charges if you become disabled.

Death Benefits

Another misconception with fixed indexed annuities is there isn’t a death benefit to pass down to your loved ones, and the life insurance company keeps your money. But, again, this is not true. Beneficiaries typically will inherit the remainder of the contract in a lump sum. Another death benefit option is called the spousal continuation clause, which allows a spouse to continue the deceased’s contract for the remainder of the initial term.

The Income Rider and Living Benefits

Traditionally, annuities generate retirement through annuitization or systematic withdrawals. Systematic withdrawals provide the opportunity to run out of money, and annuitization offers zero flexibility. That said, fixed index annuities offer an optional income rider that can provide a steady income for a lifetime(s).

The income rider or Guaranteed Lifetime Withdrawal Benefit is an additional feature available with some annuities. Annuity owners can also see increases in their retirement income with an inflation-indexed annuity.

Use a fixed index annuity calculator to estimate your retirement income better.

What Do My Beneficiaries Receive When I Die?

Fixed indexed annuities offer a simple standard death benefit: the annuity’s accumulation value or the minimum guaranteed surrender value, whichever is greater. 

Helpful tip: Life insurance might be better if you want to leave money to your beneficiaries. In some cases, you don’t need to take a medical exam. Our quoting tool helps you find the best online life insurance at the cheapest cost. Coverage starts at $9.37 per month.

Conclusion

Fixed indexed annuities can offer you several benefits to help secure your retirement. By crediting interest based on the performance of an index, these contracts provide growth potential without the risk of losing money. Additionally, they come with guarantees such as principal protection and the ability to access your money if needed quickly. And that’s not all! You may also receive guaranteed income for life and avoid probate. Request a quote today if you would like to learn more about how fixed indexed annuities could benefit you in retirement. We would be happy to discuss this option with you in further detail.

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Frequently Asked Questions

Which market index is typically associated with an indexed annuity rate of return?

Historically the S&P 500 index has been associated with index annuities. However, new and creative market indexes have been created to complement traditional indexes, such as volatility indexes, artificial intelligence, and ETFs.

Who regulates fixed and equity-indexed annuities?

State insurance commissioners oversee indexed annuities. If you have any queries regarding a specific annuity, contact your state’s insurance commissioner. You may also check whether the person selling an indexed annuity through the Financial Industry Regulatory Authority (FINRA).

How do I buy a fixed indexed annuity?

You must purchase a fixed index annuity through a licensed financial professional, typically an independent insurance agent.

What is the difference between a fixed index annuity and a variable annuity?

A fixed index annuity is an insurance product that gives you the potential to earn interest based on the performance of a stock market index without the risk of losing your principal. A variable annuity is an insurance product that gives you the potential to earn interest based on the performance of a stock market index. Still, you also have the risk of losing your principal.

What is the average return on a fixed indexed annuity?

The average return on a fixed indexed annuity is between 3% and 6% over the contract’s lifetime.

What are indexed accounts?

An indexed account is a type of account that is linked to a financial index, such as the S&P 500. Indexed accounts are often used by investors who want to track the performance of a particular index.

Can you lose money in an indexed annuity?

No, you cannot lose money in an indexed annuity. Your annuity is linked to a financial index, so it will fluctuate with the market. However, you will not lose money if the market declines.

How does an indexed annuity work?

With an indexed annuity, your return is based on the performance of a particular financial index, such as the S&P 500. The index’s performance determines how much your annuity will grow. If the index goes up, your annuity value will increase. If the index goes down, your annuity value will not decrease.

Indexed annuities also offer a guarantee that you will not lose money even if the index declines. This guarantee is provided by the insurance company that issues the annuity.

Are indexed annuities safe?

Yes, indexed annuities are safe. Your annuity is linked to a financial index, so it will fluctuate with the market. However, you will not lose money if the market declines. Additionally, indexed annuities typically offer a guarantee that you will not lose money even if the index declines.

How are indexed annuities taxed?

Indexed annuities are taxed as deferred annuities. This means that the money you invest in your annuity grows tax-deferred. You will not pay taxes on your investment until you withdraw money from the annuity.

Withdrawals from indexed annuities are subject to income tax. Additionally, if you withdraw money from your annuity before you reach age 59 ½, you may be subject to a 10% early withdrawal penalty.

What is wrong with fixed index annuities?

There is nothing wrong with fixed index annuities. They are a type of annuity that is linked to a financial index, such as the S&P 500. Indexed annuities are often used by investors who want to track the performance of a particular index.

The downside of indexed annuities is that they may not provide the same level of growth potential as other types of annuities (variable annuities). Additionally, indexed annuities typically have higher fees than other types of annuities (fixed annuities).

Are fixed index annuities a good investment?

It depends. Indexed annuities can be a good investment for some people. They offer the potential for growth but with the safety of a guarantee that you will not lose money if the market declines. However, indexed annuities typically have higher fees than other types of annuities (fixed annuities).

Do indexed annuities have fees?

Any fees associated with indexed annuities are for an additional benefit or rider, such as a lifetime income rider, enhanced death benefit, extra liquidity, or higher upside potential.

Who regulates fixed indexed annuities?

State insurance commissioners regulate fixed indexed annuities. The U.S. Securities and Exchange Commission (SEC) also has authority over some aspects of fixed indexed annuities, such as how they are marketed and sold.

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Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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