Indexed Annuities

What is an Indexed Annuity?

An indexed annuity is a type of annuity whose income payments are tied to a stock index, such as the S&P 500. Index annuities perform well when the financial markets perform well. Indexed annuities are not a direct investment in the stock market. They are long-term insurance products with guarantees backed by the claims-paying ability of the issuing insurance company. They provide the potential for interest to be credited based in part on the performance of the specified index, without the risk of loss of premium due to market downturns or fluctuations. Most indexed annuity contracts also include a yield or rate cap that can further limit the amount that’s credited to the accumulation account. This type of annuity is designed for accumulation and growth.

Why would a client need an Indexed Annuity?

Index annuities give buyers an opportunity to benefit when the financial markets perform well, unlike fixed annuities, which pay a set interest rate regardless.

Essentially, by purchasing a qualified longevity annuity contract, you can defer the distribution of a portion of your qualified assets beyond 72, reducing your RMDs until a later date.

Who needs it?

A client interested in higher returns than fixed instruments such as CDs, money market accounts, and bonds but not as high as market returns.  A client interested in a low-risk investment as every indexed annuity is insured by the State Guarantee Fund (similar to the insurance provided by the FDIC). The guarantees in the contract are backed by the relative strength of the insurer.

How best to approach/sell to your clients?

With respect to retirement planning, index annuities offer greater overall benefits than directly investing in stocks or even a market index. Debt-based instruments like bonds and CDs are a guaranteed bet (the same as index annuities), but they offer half the growth potential. This, in addition to miscellaneous advantages like tax-deferral, death benefits, lifetime income options, and probate avoidance, make index annuities a great candidate for your retirement plan.

Where it might not always apply?

Most potential disadvantages to indexed annuities are common to all retirement savings instruments, including 401(k)s and IRAs, although indexed annuities are somewhat protected with a minimum guaranteed interest rate.

  • 10% IRS Penalty: Withdrawing income before the age of 59.5 results in a 10% IRS tax penalty.
  • Not Considered a Capital Gain: Although tax-deferred at first, income is eventually taxed at ordinary rates, unlike stocks.
  • Administration Fees: Like mutual funds, some indexed annuities charge a 1-3% annual management fee.
  • Withdrawal Fees: Withdrawals exceeding the annual allowance incur an insurance company penalty.
  • Vesting Schedule: Earnings diminish when withdrawn early. A vesting schedule determines by exactly how much.

Things to consider

The exact rate of return you’ll receive from an indexed annuity is impossible to predict because your funds is linked to market returns, such as the S&P 500 or a similar stock market index. The returns will also differ from product to product. Each annuity provider will have their own method of calculating returns, and each sets their own rates.

Some annuity products have a cap, which sets a maximum rate of return, while others use a spread, which deducts a portion of the indexed returns, and participation rates. While an indexed annuities future balance is impossible to predict, we can look back at how they would perform in past market conditions.