Indexed Annuities

What is an Indexed Annuity?

An indexed annuity is a type of annuity whose account values are influenced by the performance of a named index, most notably the S&P 500. Although not directly invested in the indexing strategy, they provide the potential for growth tied to the index performance. The strategy is designed with a specified minimum performance (commonly 0% or 1% floor) with an upside cap. Indexed Annuities are intended for Growth and Cash Accumulation.

The advantages of Indexed Annuities

  • Indexed Annuities give clients the opportunity to benefit from the upside of the market with downside protection of a guaranteed 0% or 1% floor. The objective is to provide higher upside potential than their fixed annuity counterparts.
  • This could be a great solution for clients that would like to see higher growth potential than what a Fixed Annuity has to offer but provides a safety net of the guaranteed 0% or 1% minimum.
  • Multiple Indexing strategies allow the client to customize their upside potential within the contract

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?

  • Indexed Annuities can be an important part of a diversified retirement portfolio. They allow the client to take advantage of the upside potential in the market with a guaranteed minimum 0% or 1% floor. This can ensure that the retirement asset is protected even when there are downturns in the market but at the same time, providing a higher potential for growth than a fixed annuity contract.
  • Indexed Annuities have the option to “annuitize” their contract or turn the asset into an income stream guaranteed for life.
  • If your client is over the age of 72, most indexed annuity contracts are flexible to allow for Required Minimum Distributions (RMD)

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.