As the retirement population continues to grow, millions of pre-retirement and retired Americans are turning to various annuity products to bridge the financial gap between what they have and what they need. A fixed index annuity (FIA) is an insurance contract that provides retirement income.
Growth in an FIA is based on the performance of a stock market index, such as the S&P 500. However, unlike stocks, your principal investment is protected against market fluctuations, although there are caps on gains. In this article, we'll discuss how FIAs can be used as a retirement tool and what to watch out for as you educate yourself on FIA features.
Navigating the checkered past of FIAs
FIAs have come a long way since they were considered high-risk financial products two decades ago. Nowadays, certain types of income annuities have even been endorsed by the U.S. Treasury as viable tools to bolster retirement income. However, annuities with terms over 10 years have been banned in many states.
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With so many FIA products available, each with its own contract terms and varying rates, it's crucial to invest in an FIA that fits into your retirement plan based on contractual guarantees, rather than hypothetical projections. Some annuity products are designed for growth, while others are designed to generate retirement income. The best retirement plans offer practical options to handle stressors that threaten your savings or peace of mind, instead of just hoping for the perfect scenario.
As you approach retirement, you naturally gravitate toward guaranteed and stable income. During the accumulation phase of your FIA, your money earns interest based on the performance of the index it's associated with. Your premium is determined by that index's performance, but your funds are not directly invested. This means your funds can benefit from strong index performance over time without being depleted if the index goes down.
Here’s where nine out of 10 pre-retirees say they would purchase an FIA based on this feature alone.
Not so fast. The “catch” could be in the fine print if you don’t fully understand all the other features of your FIA:
- What are the fees for this particular product?
- What’s the surrender charge for early withdrawal?
- How long are the rates contractually promised to you?
- What kind of riders are available, and how might they benefit you?
This last point is especially important. The number one piece of advice we give our clients is to not pay for anything they aren’t going to use. For instance, it doesn’t help to pay for an income-increase rider if your funds are already healthy enough to sustain you through your retirement years. Perhaps something like a long-term care enhancement to double your income in the event you end up in a nursing home would be more practical. FIAs are as varied and unique as people are — we’ll help you determine which features serve your situation best.
When FIA products mature matters
Here’s something to consider. When you’re allowed to withdraw funds without surrender charges depends on the contract, which varies from product to product and company to company. It’s very important you pay attention to this time factor. You don’t want to be a 65-year-old purchasing a product that takes 10 years to mature. Be sure that you’re thinking realistically about the lifetime of your FIA, your age and life expectancy in your family (and your spouse), and that you accurately plan for health costs.
Now that you have invested funds in your FIA, you can start receiving income during your retirement. But how do you go about it? Most FIAs offer the flexibility to decide how you want your money to be allocated. Are you someone who needs to pay off outstanding debt before passing it on to your loved ones? Then a one-time lump-sum payment may benefit you.
Or perhaps you, like most retirees, need a reliable income stream and want monthly payments for life.
Some people benefit from taking out specific amounts of money at particular intervals, such as helping to pay for their grandchildren's tuition or paying fees at a retirement community.
Choosing how your funds will be distributed is as important as understanding the contract itself.
The bottom line
Annuities are a versatile retirement tool that can help you accumulate money for retirement, grow your investment on a tax-deferred basis and give you a guaranteed income stream for life. But it’s important to understand that FIAs are as different as people are — you have to find the one that’s right for you.
Bear in mind that FIAs are a piece of a viable retirement plan, not the whole plan.
No need to take our word for it. Sit down with a financial professional to decide if an FIA is right for you.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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