According to the LIMRA Secure Retirement Institute, sales of fixed-index annuities (FIA) increased 93% between 2007 and 2014. At the same time, sales of traditional fixed and variable annuities declined.1 This begs the question: What is it about FIAs that are so appealing to consumers, specifically retirees and those who are approaching retirement?
One way to explain the rise in FIA popularity is by understanding the concerns consumers might have about other types of annuities. For example, traditional fixed annuities offer a fixed rate of return for a set period. With interest rates persistently low, fixed annuity rates have been low as well, often as low as one or two percent. This might be reason for a consumer to look around for other options rather than accept returns that may not even keep pace with inflation.
On the other end of the spectrum, variable annuities allow your premiums to be invested through stock and bond subaccounts. While this offers greater potential upside, it also requires a higher tolerance for risk. Right now, markets are grappling with a slowdown in the Chinese economy, a slump in the energy sector, and the prospect of rising interest rates. For some retirees, variable annuities may be a little too risky at this point.
FIAs are often explained as a combination of benefits that includes indexed interest potential that is protected along with your principal. With an FIA, you can be credited a fixed rate of interest based on the performance of an external index, although there is no direct participation in the market.
The principal-protection aspect seems to be of utmost importance to many retirees, so let’s talk more about that. When you buy an FIA, the amount you put in is protected against loss by the insurance company, and these guarantees are backed by the financial strength and claims-paying ability of the insurer. It should be noted that early withdrawals may result in loss of principal and credited interest due to surrender charges.
FIAs are designed to meet long-term needs for retirement income, but in the event that income is needed aside from that for an emergency or a one-time large purchase, there are several ways that interest and portions of principal can be withdrawn. The most common method would be through add-on riders, which are available at an additional cost. Many FIAs also have provisions in which the contract owner can withdraw smaller amounts of principal, if needed each year, without incurring a penalty, although any distributions may be subject to ordinary income tax and, if taken prior to age 59 ½, an additional 10% federal tax.
FIAs: Handle With Care
FIAs aren’t without their critics. They are often discouraged in the media for their complexity and lack of liquidity. Some people also believe that these insurance products, in general, aren’t worth their costs and that pre-retirees and retirees may be better off utilizing other, more traditional financial vehicles within their retirement income strategy.
The takeaway here should be that FIAs maintain a strong appeal, particularly for people planning their retirements. Consumers have demonstrated that appeal through the uptick in FIA ownership during the past decade. However, retirees must be careful that they understand this vehicle properly and use it to avoid any potential headaches down the road. If you need help with the design of your retirement strategy, please don’t hesitate to contact one of our professionals today.
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