I’m amazed at the number of people who understand so little about annuities. For 25 years, I have quizzed prospects and clients of their knowledge and perceptions of annuities. Some people claim, “Annuities are evil and should be banned,” while others have named their firstborn after these popular products. Life insurance is designed to protect a client’s financial dependents in the event of said client’s premature death, thus helping to protect loved ones from financial loss. Annuities are the upside-down version of life insurance and can be simple or complex.
Annuities can be used to assist with funding education, retirement, income, death, etc. Their primary design is to protect the annuitant against the risk of living too long and possibly outliving their financial resources during retirement. Some of the more popular annuity types are variable, fixed, and fixed indexed annuities. My experience has always geared me toward safety for my clients. When it comes to safety, the fixed index annuity stands out. What exactly is a fixed index annuity?
To understand fixed index annuities better, we first must understand what an FIA is not. It is not a variable annuity. A variable annuity is a security product that is typically invested in mutual funds, while a variable annuity is usually offered through an insurance company and is considered an investment. The standard rate of growth of the annuity varies according to the performance of the investment medium.
Variable annuities pass the risk to the client and not the company. This allows gains to be passed through to the contract owner, but it means that investment losses will pass through to the contract owner as well. The client takes the financial risk because the contract owner bears the investment risk. The Securities Exchange Commission (SEC) considers variable annuities to be securities, not insurance products. Often times, I meet people who are familiar only with variable annuity products and assume that all annuities behave the same. This would be like assuming that a Saint Bernard and a poodle are the same because they are both dogs.
A fixed annuity is a product that offers a fixed rate of return. It is usually set up from a lump-sum deposit. The financial institution will provide a set rate of return for a specific period that might change or remain standard. At some point, the client can take money or income from these products. In a booming market, a fixed annuity can hinder the client from taking advantage of larger gains by providing a minimum guaranteed contract value to help protect against a declining and stagnated stock market.
A fixed index annuity is the opposite of a variable annuity. Like variable annuities, they are sold by insurance companies but are considered an insurance product. They have grown in popularity due to their safer strategies and growth potential. Bloomberg.com registers nearly 54.5 billion dollars in fixed index annuities sales from their inception.1
The fixed index annuity is similar to the fixed annuity in its relationship to providing a safer alternative and positioning. The biggest difference is that the fixed index annuity is linked to an index. For example, if the S&P 500 moves upward, the interest rate is based on some portion of the increase. If the index moves downward, the annuity credits the guaranteed minimum rate stated in the contract. Many of these contracts are equipped with a fixed interest option or a variety of ways to allocate funds.
Now, don’t run out and start buying fixed index annuities with no set purpose. Each product should be properly researched and selected from reputable companies. These products can be as different as night and day, but will most likely come with principal protection and a guaranteed minimum interest rate. This is important to many investors who are leery of the unstable economy and uncertain futures.
What makes these products popular is that they can be customized to meet the needs of the clients. If income, growth potential, or preservation of principal is important, there are many companies and products available. The income stream amount is based on the value of the contract on the date of distribution and the payout schedule you choose.
The drawbacks include waiting for a specified time period before use, and that you may not capture all the market-link growth. Growth is credited based upon the returns of a market index. Since you are not invested in the market, your potential for loss is minimized. Some naysayers push the argument against fixed index annuities because of high surrender charges and low return possibilities. It is important to consider and work with an agent that provides full disclosures of the products and companies that provide fixed index annuities.
The message they leave out is that there are various companies and products that can be custom-tailored to fit a client’s needs. Some strategies are uncapped, while others have lower surrender charges or walk-away clauses. The idea that all fixed index annuities are the same is unfair to the industry, as well as to the individual trying to make a decision based on an impartial evaluation.
With an uneasy economy and changes in the Oval Office, prospects are looking for safety more now than ever. .2 Whether you win or lose, you pay the casino a small percentage, but you never place your original bet in jeopardy of loss. In a nutshell, you can receive growth potential in a solid, flourishing market but are provided added protection in a declining one. An additional income rider that can provide a guaranteed income for life is sometimes offered by financial companies. It is important to note that anyone representing any product should be very careful to disclose all the dynamics. Keep in mind that one size does not fit all.
Also keep in mind that products can be different from year to year. Companies can change and alter their products depending on the economy, laws, and the demands of a changing market.
1The Financial Talker. Fixed Indexed Annuity: Suze Orman and Fixed Indexed Annuity. August 2012. Suze Orman. .
2 Tony Robbins. Money Matters. Page 435.
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