An Index annuity can play a role in your long-term retirement plan. You just need to know what you’re looking for.
How much do you understand about annuities
For most of you reading this, stocks, bonds, ETFs, and mutual funds are probably understood pretty well. And for the most part, that’s all people need when they’re in their working years. Annuities are mainly used for people nearing retirement or in retirement.
The biggest product in the market right now is something called a fixed index annuity or FIA.
So what’s the buildup and excitement about these FIA’?
Fixed Index Annuities are the current hot product and will remain so while people perceive the market potentially being volatile.
Volatility as you all know is the market going up and down and up and down, over and over again.
So how does it protect you from valatility?
It’s actually based off a crediting system and not on the actual stock market. Meaning that the insurance company will credit any positive returns to your account and disregard any negative returns. Meaning that your principal, the money you went into the annuity with, will not go down.
This means your account only gets to go up, and not down. And for those people who don’t want to experience another 2008 or 2001 market crash, it’s a widely popular tool to avoid volatility.
So if it’s so good, what’s the catch? Everything has a catch.
Quite simply, annuities lock in your money for a certain period of time. Whether it’s 5, 10, or 15 years. That money is going to be pretty illiquid, meaning you can’t access it. Most annuities do give you a free 10% withdrawal every year, but for some people, it may not be enough.
Any withdrawal over the 10% mark will be penalized. Think of it like your TSP account, if you withdrew money before you were 59 ½, you would be penalized. The same principle applies here, but instead of an age limit, it’s off a yearly limit.
The other catch is that they may limit caps or participation rates.
What is a cap and participation rate?
To put it simply, caps would be the maximum you can earn in that annuity for that year or for the entire account. So a sample of that would be if the cap is 30%, if the market returns over 30%, like 45%, the insurance company gets to keep the 15% difference.
Participation rate is how much of your money will be counted towards the crediting system. So if it states 80%. If you dump in $100,000, they’ll only credit your account as if it had $80,000. So if the market returns 10%, instead of seeing $110,000 you’ll see $108,000.
Why? Because 10% of $80,000 is $8,000.
So one of the two biggest things to look out for in these fixed index annuities is their participation rate and their cap limits.
In the end, you have to understand that insurance companies are out there to make money too, they are classified as “for-profit” companies. But on the same hand, they want people to put money into their company and invest with them as well. Just understand that there are tradeoffs on any decision you make.
So who should buy these annuities?
People looking for security while getting a return similar to that of the stock market. It’s for those who don’t want to go from $100,000 to $50,000 in a few years. While still wanting to carry some type of return, rather than putting it into a savings or checking account.