What is a fixed index annuity?
Fixed index annuities can help protect and grow retirement income.
An annuity is a contract between you and an insurance company. You pay the insurance company one or more purchase payments (called premiums), and in exchange, you receive benefits that include:
Guaranteed income payments – You have the option to receive guaranteed income for the rest of your life. Your income is based on:
Premium amount + interest earned – withdrawals/surrenders
Option for increasing income – if you choose an annuity with the option for income with the potential to increase, you can receive increases to your lifetime income withdrawals based on any interest your contract earns in a given year. Increasing income options are typically available through either built-in or additional cost riders.
Potential for growth – With fixed indexed annuities, you have the ability to potentially earn interest based on the positive performance of an external market index.
Tax-deferred growth – Since an annuity is an insurance product you don’t have to pay ordinary income taxes until you begin receiving money from your contract. Compounded over time, this can increase your savings and the income your annuity generates. Withdrawals are taxed as ordinary income and, if taken prior to age 59 ½, a 10% federal additional tax may apply.
Tax deferral is also a benefit of traditional IRAs and 401(k)s. However, annuities don’t have any government-imposed contribution limits. Because of that, they can be a good choice if you want to save more than IRAs and 401(k)s allow and still enjoy tax deferred growth potential.
This hypothetical chart shows how a $100,000 initial payment, compounded at 4% annually, grows tax-deferred. Twenty years later, after taxes are paid on the lump-sum distribution, the amount is greater than the amount accumulated in a taxable product after 20 years.
Assumes a 33% ordinary income tax assessed yearly on taxable earnings and at period end on tax-deferred earnings. If a withdrawal or distribution is taken, the tax deferred earnings would be reduced by income taxes on any interest and, if taken prior to 59½, a 10% federal additional tax may apply.
- Access to your money – Many annuities allow you to withdraw up to a certain percentage of your money every contract year (after your first contract anniversary) without a withdrawal penalty. This can help in the event of some financial emergency. (There may be a penalty for withdrawing more than the allowed percentage and tax implications).
- A death benefit for loved ones – A death benefit provides the ability for you to leave a legacy to your beneficiary(ies). If you base your annuity contract on the lives of both you and your spouse, whoever dies first, the income payments will continue for the life of the surviving spouse as long as you choose lifetime withdrawals. The benefits received are based on the terms of the annuity contract you purchase.
Disadvantages of annuities
Like most retirement savings instruments, annuities have drawbacks as well as advantages. Here are some things to consider before purchasing an annuity:
- You may have to pay a 10% additional tax for withdrawing income before age 59½.
- The income you take from your annuity is considered ordinary income and taxed at ordinary rates, unlike some investment options like stocks, which may be considered a capital gain.
- Many annuities come with wide range of fees and charges, such as additional cost riders for different options and Market Value adjustments for early withdrawals.
- You may incur withdrawal charges for withdrawing more than your contracts allowable amount in a given year. Be sure to check what annual amount your contract allows and if it changes as the years of your contract go by.
Is a fixed index annuity right for you?
An annuity may be a good fit if:
- The fluctuations of the stock market stress you out
- You want guaranteed, predicable income in retirement
- You’re concerned about outliving your savings
- You want to take advantage of tax-deferred growth
- You’re able to leave the money in your annuity until you need income
An annuity may not be a good fit if:
- You already have enough assured income
- You don’t have enough money to contribute to an annuity
- You need the ability to tap into your annuity for an emergency or unexpected expenses