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Index Investigations: Are Indexed Annuities a Good Investment?

Are you deciding whether indexed annuities are a good investment?

The S&P 500 market index has an average annual return of 10% based on historical data. Adjusted for inflation, it would be 7%.

It’s only one of the figures to look out for when investing in fixed indexed annuities. On top of that, you can enjoy guaranteed returns. It means they have fewer risks than variable annuities.

That said, indexed annuities can be a good investment. However, you have to understand it completely. At the same time, you have to be aware of the risks involved.

Read on to learn if indexed annuities will work for you.

What Are Indexed Annuities?

With indexed annuities, also known as equity-indexed annuities, you don’t invest directly in the market. You invest through your insurance company. It would then invest your money using your chosen index.

An index annuity is a contract between you and your insurance company. You can either make a lump-sum payment or a series of premium payments. You then receive the returns either as a lump sum or via periodic payments.

It’s what makes indexed annuities different from fixed annuities. It has a guaranteed interest rate and won’t vary beyond the contract.

An equity indexed annuity, on the other hand, has a market-based return on top of a guaranteed return. It’s also different from a variable annuity. It deals with bonds, stocks, and money market instruments.

You can choose one or split your money across several. The available index depends on the insurance carrier. The most common indexes are the S&P 500, Nasdaq 100, or Russell 2000.

Take note, the SEC doesn’t regulate all indexed annuities. It only regulates security-based indexed annuities.

How Much Do You Gain with Indexed Annuities?

The answer depends on the insurance carrier. Companies have different computations, rates, and rules. Some even change their participation rates and caps after you bought your annuity. It’s a legal practice.

You must understand the details and the fine print before buying any type of annuity. It allows you to learn how much you can gain from your investment. The guaranteed minimum returns also depend on your current state.

The guaranteed minimum in most states, for example, is 1% to 3% interest on 87.5% of the insurance premium paid. It can still vary depending on the company, but it should give you a more concrete idea.

Aside from that, you get returns linked to the performance of a market index. The computation can be a head-scratcher as it varies from one insurance carrier to the next. Here are some terms you should know about.

Participation Rate

The participation rate is how much of the market gain the insurance companies will pass on to the annuity holder. If the index rises by 15%, you don’t get as much on your annuity. It still depends on your contract’s participation rate.

If you have an 80% participation rate, the company would credit 80% of the 15% index gain. It amounts to 12% credited to you.

Caps

Some insurance companies also put a cap on market-based returns. It’s the maximum amount you can earn in a given period. 

If you have an 8% cap, you’ll get a maximum of 8% regardless of the participation rate. Even if the index goes beyond 50%, you’ll still only receive an 8% credit.

Spreads

The spread is a baseline subtracted from the market-based returns. You’ll only get credited with interest if the index goes beyond a certain number.

Let’s say your annuity has a spread of 4%. If the index rises at 4%, you get nothing. If the index gains 9%, you’ll get a 5% credit.

Spreads have the same impact as a fee or commission. Even if the investment is a “no fee” annuity, you won’t get the full amount anyway.

Buffer/Shield

What if the index goes into the negative? Don’t worry, many insurance companies offer a buffer or a shield to absorb a percentage of losses before you take a loss on your annuity.

A buffer of 10% would give you a shield against index losses of 10% and below. If it declines by 12%, your annuity declines by 2%.

Can You Change Your Mind with Fixed Indexed Annuities?

If you ever want to put your money in other investments, it’s difficult with an indexed annuity. To protect their investments, companies often impose steep surrender fees.

It means withdrawing your money for whatever purpose within the period specified in your contract, you’ll have to face a surrender penalty. You’ll get significantly less than the amount of your annuity.

Most insurers have reduced the surrender periods. Still, you may have to stick with the annuity for five to ten years before the surrender period expires. If you don’t want to lose money, you can’t back out of the contract.

If you were thinking of using the money to buy a house for your retirement, you’ll have to find other ways. You may have to start searching “how can I buy a house with no money down” on Google.

Some companies allow you to withdraw a certain amount. In most cases, these firms allow withdrawals of up to 10% of your account value after the first year. 

You won’t suffer from a surrender fee if you stay below the allowable amount. Of course, pulling money out impacts the entire account’s value, so it’s not always a wise decision.

Learn If Indexed Annuities Are for You

Indexed annuities can be good for your portfolio. After all, it has limited downsides. However, its low risk means having limited upsides as well. They have the characteristics of both fixed and variable annuities, allowing them to offer the best of both worlds.

Still, you have to look into the fine print as calculations can be complex. Find the best fixed index annuity rates for you.

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