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Is a Fixed Indexed Annuity Ideal for You?


Maybe you're a conservative investor, but today's low interest rates have even you looking to punch up your investment returns. You're not alone.

It's not surprising then, that Fixed Indexed Annuities (FIA)s are growing in popularity. Sales of these products hit a record high in 2012 – $33.9 billion, according to LIMRA, an insurance industry research firm.

In case you're wondering what a FIA is, to try to make it simple, an FIA is an insurance product designed to protect a person's savings from the risk associated with the stock market, explains financial advisor Stephen Cagnassola of The Safe Money Umpire. Their intent is to provide a return that is linked to a stock market index, such as the S&P 500 index. "At no time is an individual's money 'in' the market. The return (if any) is calculated based on a formula (pre-determined) on a year to year basis," he says.

When there is a positive gain in the underlying index, then the individual policy holder would be credited with a rate of return that, in many cases, is higher than what a similar fixed interest product, such as a certificate of deposit (CD) would provide. If the stock market index is negative, then the person's account would not be credited with any interest. However, he says, they would not lose any interest or principal either.

Why FIAs are attractive

"FIAs fit a middle ground between CDs and the stock market. Many people want to place their money where it is not subject to the ups and downs of the stock and bond markets. Traditionally, this has been CDs or Money Market accounts at banks. But in recent years these accounts have paid very little interest, not even keeping up with inflation," says David Shucavage, president of Carolina Estate Planners.

What are some upsides of FIAs? "An advantage they have over bonds is protection from market declines due to rising interest rates, elimination of bond default risk, and participation in an advancing stock market. FIAs guarantee you a base interest rate, plus earnings from whatever stock market index you select," says James Comes, a wealth advisor with Carson Wealth Management Group.

However, most contracts cap the annual upside at about 4-5% of what the market index does, so it pays to do your homework and check around, cautions Comes.

What you need to know

Like all investments, FIAs have downsides. "You generally have to to commit for 5-10 years. The longer you commit, the higher the cap rate," explains Comes. If you choose to withdraw your money early, surrender fees can be 10% and up.

FIAs have downsides. "You generally have to to commit for 5-10 years. The longer you commit, the higher the cap rate," explains Comes. If you choose to withdraw your money early, surrender fees can be 10% and up.

Since you have a "contract" with an insurance company, you want to be sure you are dealing with a top flight organization that is highly rated by Best, Standard & Poors and Moody's.

Realize too, that you can't run from Uncle Sam forever, your earnings will be taxed ordinary income tax rates at some point in the future when you withdraw from non-IRA accounts, says Comes.

Buyer beware. There are literally hundreds of products and index strategies out there today. "This has caused a great amount of confusion to those who buy them, as well as inexperienced sales people who do not understand them," points out Cagnassola.

These products can pay "nice" commissions and therefore can be mis-sold, says Comes. Translation – because there is a financial incentive, the person selling you the FIA could sell you what pays them the highest commission versus what's best for you.

Who is ideally suited for an FIA?

"They are especially good for the Millennial crowd because there is so much uncertainty swirling around social security and pensions, and 401(k)s are not enough to balance out a retirement plan. Millennials need to prepare for the fact that retirement funding that used to be around may not be available when they retire in a few decades," says Ellie Kay, author of The Little Book of Big Savings, who works with the Indexed Annuity Leadership Council, a consortium of life insurance companies, www.fiainsights.org.

They can also be ideal for older people. Cagnassola says his average aged client for an FIA is someone 55 and up to age 72. "Although others would argue that they are suitable for anyone. I disagree, because an average surrender period (period of time that money is unavailable for a full withdrawal) for an FIA is 5-7 years. That would mean that a person aged 55 would have full liquidity after 5 years, thus getting them past the penalty for early withdrawal at age 59 ½. And on the higher age of 72, a 5-year FIA would give them full liquidity at age 77."

The bottom line, FIAs can be complicated. You can study up on them here:

Says Shucavage, "Fixed Indexed Annuities are considered to be very safe. Each state monitors the financial health of resident insurance companies and their assets. Most states have an insurance guarantee association that provides additional protection for policies."


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Comments

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5 comments.
Comment #1 by Ken Tumin posted on
Ken Tumin
As many of you know, these types of annuities have many downsides. Some of the downsides are mentioned in the article. Feel free to comment on additional downsides. Please don't consider this article to be an endorsement of these annuities.

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Comment #3 by Anonymous posted on
Anonymous
Ken, I have index annuity with North American, I wish I never opened it. The returns are paltry less then 2% a year and you are committed for at least 10 years. If you cash out, the penalty are 14% of the principle the first few years and then gradually falls of to 2% on the 10th year. Even dough you don't pay interest on the credits, it is accumulative and must be paid when you close the annuity or annuitize it. If you annuitize it today, the interest on the payout is 1-2% (bellow the CD rates).
Not worth it to even bother with it. I have few more years to go, but will cash it out and pay tax on all of the accumulated interest and will not annuirize it at all, my mistake.

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Comment #5 by Anonymous posted on
Anonymous
Wouldn't touch an FIA, or any annuity, with a ten-foot pole.They're all potential mine-fields which can blow up in your face at any time.

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Comment #15 by Anonymous posted on
Anonymous
I did some reach into this as I was suggested to buy the product. Besides what are mentioned in the article, I can think of the following downsides:
1. there is participation rate to limit the amount of gain you can get. For example, if the index went up 10%, the participation rate of 60% will only give you 6% ; participation rate of 80% will give you 8% return. This rate can be changed by insurance company every cycle: the cycle can be yearly if your gain is credited every year, or multi-years if your credit cycle is multi-year. The yearly one is more common and popular.
2. there are caps in place to limit the amount of gain you can get. the insurance sets a cap for the max return you can get. I've seen as low as 3% cap, as high as 13% cap. so, when the index do extremely well, your gain is limited. For 2013, the S&P went up 26%. You can get max of 13%, or 3%, depending on your cap.
3. the guarantee rate normally is not on your whole account but a percentage. it's very complicated so I am not going to explain how and why here. I have not seen any brochure show this. I knew because my friend was taking a training class in it. 
4. the surrender period of 5-7 is not long, most has 10 years, some older ones has 15 years surrender period. And you have 10% penalty if you withdraw money before 59.5 years old (by IRS), even if you passed the surrender period.
5. if the insurance company goes bankrupt, your money is not insured, unless insurance companies' co-insurance can cover this.

I think it is for people who's 1st priority is to keep principle, and is willing to give up some gains, and don't need those money until after the surrender period or after 59.5.

For very young folks, I wouldn't suggest it, because the market performs much better than the FIA in a very long period. Of course, you need to be disciplined, keep investing money, say in a Vanguard index fund, no matter the market is up or down.

As Sheryl mentioned, there are ton of FIA out there, and every one of them is different in some way. There are many details and you can easily miss one thing, and the marketing material is very high level. Sometimes even the agent don't know, or they misunderstand what it means (I had experience in this when I was looking into some of the products).

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Comment #19 by Anonymous posted on
Anonymous
Two items of potential interest...Had a client several years ago that "invested" money into a 403b annuity program with fixed interest rates...the problem (then) was the new money earned a higher interest rate than the old money and one was "seemingly" locked in with the old money.  Raised the issue with the ins co. on the way interest was calculated on "old" money and the answer was..."explained in the transmittal letter with the annuity."  Asked whether the letter was part of the contract?  And they finally allowed a roll over to an IRA...asked to see a proforma 1099, i.e. didn't want the client to have a premature distribution before 59.  All worked out good.  Suggestion:  If not properly discussed get appropriate advice.

Second, I currently have a client that is over 701/2 and thinks that the QCD will be renewed but the "twist" is...if law is renewed, how can one make a charitable distribution from an IRA to a non-profit, e.g. university and use some of the money to "buy" an annuity from that non-profit?  Of course, some amount may be disqualified for complete QCD distribution but he thinks the numbers may justify the action....anyone know of a university, etc. that is "playing in that pond?"  

Thanks

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Comment #2 by gregk posted on
gregk
Interested to know from any members with FIA's here what their total return was in 2013?  How much of the big stock market gains did they share in?

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Comment #6 by Anonymous posted on
Anonymous
There is an upper limit of 3% with Lincoln national, could be more or less depending on the company and not all of you money work for you. The stock can double in any year, but you are limited to just few percentage points on the upside, waste of your money. Only good thing is that you do not lose money in any year when the stocks go down.

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Comment #9 by QED posted on
QED
Actually you do lose the interest you otherwise would have earned if your money were instead in an insured CD.

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Comment #4 by Shorebreak posted on
Shorebreak
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Comment #7 by Anonymous posted on
Anonymous
And the payout rates are in 1-2% for a life time income and you give your money away forever to the charity.

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Comment #10 by Shorebreak posted on
Shorebreak
The intent of a charitable gift annuity is just that, a "gift" in return for a life-time stream of income. For example, the chart below illustrates a range of ages for Harvard’s gift annuity rates, payments, and deductions for a $25,000 one-life gift annuity. Harvard’s gift annuity rates are capped at 9% for those 85 years of age and older. Note at age 65 the "payout rate" is 5.9%, not "1-2%".

http://www.law.harvard.edu/alumni/support/planned-giving/gift-plans/charitable-gift-annuity.html

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Comment #13 by Anonymous posted on
Anonymous
#10, Shorebreak, the interest is 1-2%, you are mixing the return of the principle with the actual rate of return. I did speak with them few months ago. Call them and verify. They count the money from the principal plus the 1-2% interest as payout rate pf 5.9% and if you die, all ends there in their pockets. You can not pass any money left over to nobody, i.e. if you die few months later after buying into, all of the money is kept by them.

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Comment #20 by Shorebreak posted on
Shorebreak
The object is a continuous income stream for the remainder of your life. For those with no heirs it's a product that gives them a good income. That's why it's a "gift'. You are not familiar with the annuity.

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Comment #18 by Anonymous posted on
Anonymous
Shorebreak, that is what they tell you when try to open an annuity. The return of the principle is included as a rate of return on your money, but they never tell you that your money is being returned and counted as interest on your money. Depending on your longevity, you may not even receive your money back ever.
Lies after lies from any insurance company. If you get 10 year period certain annuity, the interest rate in your money is paltry 0.0071% but it says 5.5% rate of return. Do you get it now?
They counted the return of your own money as like you are receiving great rate of return. At the end of 10 year you get nothing, because all of your money has already been returned.

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Comment #21 by Shorebreak posted on
Shorebreak
"Depending on your longevity, you may not even receive your money back ever."

You don't understand the product. One doesn't receive the money back. You die. The object is a good income stream for the rest of your life.

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Comment #8 by Anonymous posted on
Anonymous
If anyone were to consider a charitable trust, a Charitable Remainder Unitrust might be worth considering. Here, an individual can stipulate a reasonable rate of return for life, or joint lives, and the remainder will ultimately go to a named charity(charities). In addition, a charitable deduction is allowed to the donor in the year the trust is funded. The annual payout to the donor is normally fixed at a certain percent of the trust fair market value, and not dependent on the trust earnings. Anyone that may be interested in such a trust, can do some Google searches or talk to a tax professional. In certain situations, it can be an ideal vehicle to accompolish certain objectives.

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Comment #11 by Anonymous posted on
Anonymous
Charitable Gift Annuities are tricky and not simple "investment" tools.
http://www.forbes.com/sites/baldwin/2012/06/06/does-a-charitable-gift-annuity-make-tax-sense-for-you...

The first question to ask about any annuity concerns principal. If you tie up $200,000 in an annuity and are suddenly faced with expensive healthcare costs you may rue the day you signed the "deal". The latest fad is to sell annuities as a substitute for not having a defined benefit plan. The truth is your $200,000 is worth about $188,000 the moment the ink dries AND you will incur further penalties if you try to access principal ahead of schedule. Commissions drive annuity promotions and sales more than anything else.
Caveat Emptor!   

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Comment #22 by Anonymous posted on
Anonymous
#4, and why I should give my hard earned money to a charity, so they can start paying my own money back in drips and drabs with almost no interest on it?
Hell, I can do it for you, give your million and I will pay you $20,000 a year for as long as you live. I bet you will not live long enough to collect half of it. And in mean time I can play with your money and collect the benefits just for me.
Charities are for the billionaires who never worked hard for the money and they need deductions instead of paying the same money in taxes.

And as a final negative, every penny you earn from any annuity is taxed at regular tax rates and if you have SS will make you pay tax on your SS benefits and if you are wealthy enough, the annuities can put you in the 40% + tax bracket. And have you ever considered that after 20-30 years the inflation will make your benefits very small and all money received after the longevity period expired is 100% taxable.

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Comment #12 by tommyvjr posted on
tommyvjr
i would never surrender my money to any insurance company (annuity) again. back in the days i bought annuity, was told they will beat the banks, so i believe him (like an idiot), 2 years later the annuity was paying 4% while the bank cd was paying 8%, i cash out and paid the penalty, and later on i made up the loss, as years was going by, the annuity was still paying less than the bank cd. people need to read the fine print on these annuity...PS annuity has all kinds of charges and expense add to it.

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Comment #14 by gregk posted on
gregk
Substantively (if not legally) FIA's are almost always shams in my judgement, - and especially so in our unprecedently low interest rate environment, which will (typically) condition the payout over the contract's entire life even should rates dramatically rise. 

Insurance companies show no greater integrity in structuring these agreements than they do with other of their products.

The likelihood of regret is extremely high.

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Comment #16 by Anonymous posted on
Anonymous
I agree that FIA's are usually and generally not a good idea.  Whether by design or not, the terms are confusing and this leads to potential situations where the typical consumer can receive mis-information, esp. with the conflict of interest related to the generous upfront sales commissions.   The typical consumer will not read or understand the language of the fine print, and herein lies the big problem - they need to rely on the information from the sales pitch. Remember, these are some of the most profitable products for the industry.  I don't mean to bad mouth these products, it's just that I have not heard many favorable outcomes from people who have bought these products and fully understood what they got.  Would be interested to hear otherwise. 

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Comment #17 by Anonymous posted on
Anonymous
Sounds just like ACA!

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Comment #23 by Anonymous posted on
Anonymous
 # 17     Sounds like B. S.

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Comment #24 by Anonymous posted on
Anonymous
Come on, the ACA should have been posted as a simple PDF for all to read prior to voting. The same goes for financial documents...read AND understand what you're agreeing to before you sign! Annuity contracts can run to 40 pages and there's a reason for all that verbage and fine print.

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