There are five very good reasons to consider a fixed indexed annuity as a component of your retirement income plan. An insurance carrier is able to provide each of these five advantages to you as long as you are able to make a time commitment to the carrier.
Possible reasons to consider a fixed indexed annuity
Possible Additional Benefits
Safety from Market Losses
If you are like many people, your top priority when you are saving your money is safety. No one puts their money in a place where they expect to lose it. We put our money in a place where we expect to get it back one day, hopefully with some nice growth.
The great thing about fixed indexed annuities is that they offer multiple levels of protection, which makes them the gold standard of safety.
With these three levels of protection, there is excellent safety in a fixed indexed annuity.
Once you are satisfied that your money is protected from market drops, your next objective may be to have your money grow. The annuity industry invented fixed index annuities precisely so that they could offer the potential for better growth potential by having the credited interest rate based on the movement of an outside market index.
Fixed indexed annuities do this:
This combination of upside potential and downside protection is very powerful.
The illustration below shows how this combination works on a typical fixed indexed annuity. Years that the index increases in value are shaded in green, and notice that in these years, the annuity credits interest based on the increase in the index. Years that the index decreases in value are shaded in yellow, and notice that in these years, the annuity does not lose any value.
You want your money to grow as fast as possible, and besides having high growth potential, some sort of tax advantage helps to accomplish that goal. It often makes little financial sense to pay income taxes on money that you are not using for current income. A tax advantage can be one of the easiest ways to make your money more productive without taking on risk.
Annuities have a tax advantage, and that advantage is tax deferral. As long as you don’t touch the money in your annuity, you pay no taxes on the interest as it is being credited to your annuity. The recognition of taxable income is delayed – that is, deferred – until you withdraw money from the annuity.
Also, you can use an annuity as the funding vehicle for IRA or Roth IRA money, although keep in mind that the Internal Revenue Code provides tax deferral to IRA’s, so there is no additional tax benefit gained by funding an IRA with an annuity. Consider the other benefits provided by an annuity to determine if an annuity is the right choice for your IRA.
A key retirement planning advantage with fixed indexed annuities is that the carrier provides a guaranteed minimum level of retirement income. Over time, as interest is credited to the annuity, and as long as you are not taking withdrawals from the annuity, the amount of that guaranteed income level can only grow, not shrink.
That guaranteed income can be provided in one of two ways.
With either option, you have the peace of mind that comes from having an assured, guaranteed income for the period you have chosen. Notice that with an annuity, you can choose to have the carrier guarantee an income that continues for the rest of your life, or for both your and your spouse’s lives, giving you a potentially excellent level of financial security.
Beneficiary Planning Advantages
You may be at the point in your life where you are motivated to consider what will happen to your money after your death. Annuities have some advantages that could be very helpful to some people as they plan for how to pass their money to their beneficiaries at death.
One advantage is speed. With an annuity, as long as you have a properly designated beneficiary, you can normally avoid the sometimes lengthy and expensive probate process. So an annuity can be one of the quickest ways to get money to a beneficiary after your death.
Another advantage is privacy. With an annuity, you get to name a beneficiary and avoid passing assets through your will. This can allow you, for example, to direct money to a particular child who has been very helpful to you as you have aged, while still having your will provide for an equal division of your other assets between all your children.
The Foundation: A Time Commitment
Most people recognize that liquidity, safety, and growth do not co-exist very well. For example, with a checking account, you get excellent safety and total liquidity, but most checking accounts pay little or no interest. With stock market mutual funds, you get good liquidity and hopefully a good rate of growth over time, but you are sacrificing safety because there is no guarantee that you will even be able to get back what you invested when you actually need the money.
So, with financial products, there are trade-offs. You cannot get all of the most desirable features and benefits in one product. They all have a purpose and can complement each other in a well-designed and diversified plan. Since an annuity is going to give you safety of principal and growth potential, it is reasonable to assume that there has to be a trade-off somewhere, and it is with some sacrifice in liquidity.
Fixed indexed annuities require that you make a time commitment, and they enforce that time commitment by a surrender charge. When you consider buying a fixed indexed annuity, make sure you are comfortable with the length of the surrender charge, because your access to your principal is limited during the surrender charge period.
Your time commitment can typically range from 3 to 16 years, depending upon the features and benefits that appeal to you. The time commitment does not mean that you do not have any access to your funds. Many annuity products allow earned interest to be taken after 30 days and others allow up to 10% of your annuity’s value to be taken each year after the first year without penalty. Of course, if you do not need your funds, leave them in the annuity to accumulate on a tax-deferred basis until you decide to begin taking income payments.
This is contrary to bank certificates of deposit that typically only allow interest to be withdrawn and will impose an early withdrawal penalty for any principal withdrawn. So to be able to enjoy the unique benefits that annuities provide, you have to allow the insurance company to hold your funds just like you would allow a bank to hold your funds.
With annuities, just as it is with certificates of deposit, there is generally a correlation between the time commitment that we allow the institution to hold our money and the productivity of our funds. The longer we commit to letting the bank or insurance carrier hold our funds, the higher the rate of interest or upside potential we can enjoy. A 5-year certificate of deposit will usually pay us a higher rate of interest than a 1-year certificate of deposit. The same principle holds true with a fixed indexed annuity. A 10-year product, for example, will typically offer a higher fixed interest rate and higher indexed-based interest crediting than a 5-year product.
If you take out more than the penalty-free amount (which varies by carrier and product), there can be substantial surrender penalties imposed (perhaps as high as 20% of the annuity’s value for a premature withdrawal), so you want to use an annuity as a part of an overall plan where you also own other accounts that have no surrender penalties for your short-term liquidity needs. Use these other accounts for emergency funds and to pursue financial opportunities that arise. Remember, annuities are designed to provide safe growth prior to retirement and guaranteed income streams during retirement. They are not designed for short-term liquidity. You will want to have sufficient funds for that purpose in other accounts, such as checking, savings, and money market accounts.
Choose fixed indexed annuity products for a specific purpose, such as principal-protected growth and income generation, where 100% liquidity is not needed during the surrender charge period. Once the surrender charge period is over, you can withdraw any and all of your money from the annuity at any time without a surrender penalty. Keep in mind that withdrawing money from an annuity will usually result in reporting of taxable income and, if taken prior to age 59½, may result in a 10% penalty tax on earnings.
Possible Additional Benefits
The annuity marketplace is very competitive, and thus carriers often have attractive additional features designed to differentiate their products from the competition. Some fixed indexed annuities have features such as these noted below:
In summary, you can see that annuities offer a lot of positive features – safety from market losses, growth potential, tax advantages, income guarantees, and beneficiary planning advantages – all built on the foundation of the time commitment that you make to the carrier.