Understanding the Indexed Fixed Annuity

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Scott Financial Solutions      

Your Wealth Preservation Experts

One popular type of investment for people looking for safe places for their money during retirement is the indexed fixed annuity. However, there is more to this annuity than you might see at first glance, and it’s important to understand all the ins and outs before you choose to invest.

What is an Indexed Fixed Annuity?
An indexed fixed annuity offers investors both safety and potential gains. If the market goes up, you participate in those gains. If the market goes down, though, you don’t lose money. Exactly how much you can make with an indexed fixed annuity depends on the terms of the specific account.

When you invest in an indexed fixed annuity, the insurance company puts your money into an investment grade bond or treasury portfolio. When that portfolio generates interest, they then invest the interest in the market. Note that they never touch the principal, just the interest. They use it to buy options, specifically calls. When the market goes up, they pull out the gains, buy more of the bond portfolio, and the gains become principal. Therefore, when the market goes down, the bonds aren’t affected and so your income flatlines.

This type of investment has been popular recently because, even with increased market volatility, investors are able to get the market upside without the downside. However, most indexed fixed annuities do not allow you to get all of your gains. In return for your money’s safety, you turn over some of what you make to the insurance company.

How Can My Indexed Fixed Annuity Earnings be Limited?
It’s important that you understand how your earnings can be limited in an indexed fixed annuity, so you can read the terms and figure out if a particular investment is a good idea for you. Most annuities will limit your gains in at least one of the three ways discussed below, and your goal is to lose as little as possible.

First, insurance companies may set a cap, or a ceiling, on your earnings. For instance, they may say that the most you can make in a year is 8%, or even 15%. The specific cap depends on the terms, and your goal is to get as high a cap as possible, or maybe even no cap at all.

Many companies that don’t cap your earnings charge you a fee instead. Again, the specific fee varies by account, though 2% is common. This means that, no matter how much the market gains, you subtract 2% and that is your gains. So if the market goes up 20%, you gain 18%. You want to be sure that a fee is only charged when the market makes money, so your account doesn’t end up losing value.

Finally, some insurance companies will only give you a percentage of the gains. Many companies will offer you 80% of what the market makes. This means that if the market goes up by 20%, you get 16% of that. However, if the market loses, you don’t lose anything at all.

In general, companies will offer better terms for a longer term accounts. These accounts can take anywhere from 0-20 years to mature. The longer the term, the higher the yield, and the more money to put into the market from that yield. The sweet spot seems to come for terms between 7 and 14 years.

How Will My Indexed Fixed Annuity Interest be Credited?
When insurance companies calculate your earnings on an indexed fixed annuity, they use one or more of the major indexes, like the S&P or the NASDAQ. Usually, you can choose the index or indexes you want tied to your account. After that, there are two ways they can credit your earnings.

The first strategy is called point-to-point. This will usually have a period of one, two, or five years. The company will note where the market is at the beginning of the investment period, and then will look at where it is at the end. They see how much the market has gone up, and that is how much gain you’re credited with. If the market goes down, your account flatlines.

An example of this is an annual point-to-point account. If the index starts at 1000 when you invest and it’s up to 1200 a year later, that indicates 20% gains for you, minus any cap or fee, of course. If the market goes back down to 1000 a year later, though, you don’t lose money. And if it’s back to 1200 at the end of the third year, you gain 20% again.

It’s important to note that the market doesn’t have to go above 1200 for you to get gains. Anytime it goes up over the period of your account, you gain, even if it crashed previously.

A second crediting strategy popular with indexed fixed annuities is called monthly averaging. With this method, the company looks at where the market is each month. They add up these numbers, divide by 12, and that indicates your percentage gains.

Neither of these strategies is necessarily better or worse than the other. If the market is going straight up, point-to-point will gain you more interest. If it’s volatile or you’re concerned about one bad day wiping out all of your gains, monthly averaging is a better strategy.

Once again, you’ll need to read the fine print to find out exactly how each strategy will be handled. For instance, some companies will cap your point-to-point earnings at something like 2 ½%. If this will not work to your advantage, you may want to choose another account.

You can usually choose which crediting strategy will be applied to your accounts, and you can often change each year, or have a percentage of your money handled one way and the rest handled the other.

If you have questions about these crediting strategies or indexed fixed annuities in general, Simply call 602-750-3891 or 520-705-4596 

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To get more information so you can make the best decision for you and your family, call:

Scott Financial Solutions

Your Wealth Preservation Experts

602-750-3891 or 520-705-4596