Fixed index annuities have become popular for retirement planning, largely due to their potential for growth and protection of your initial investment. However, before you lock in your choices for your future retirement income, let’s talk about the potential risks of these popular products.
Your Principal Is Protected With Fixed Index Annuities
Fixed index annuities are insurance contracts that offer a combination of features found in both fixed annuities and variable annuities. They are linked to the performance of an underlying stock market index and are designed to provide an opportunity for growth balanced with protection against market downturns.
One of the primary advantages of a fixed index annuity is the protection of your initial investment, often referred to as the principal. The insurance company guarantees that your principal will not decrease due to market fluctuations, regardless of how the underlying index performs. This means that, even during market downturns, your initial investment remains intact.
Not only do you get principal protection with a fixed index annuity, but you also get some potential for growth. The interest credited to your annuity is based on the performance of a specific index, such as the S&P 500 or the Dow Jones Industrial Average. If the index performs well during a given period, your annuity is typically credited with a positive interest rate. If the index performs poorly, you won’t earn anything, but you won’t have to worry about losing any of the money you put into it.
What Else Can Impact Returns From a Fixed Index Annuity?
While you can’t lose your principal with a fixed index annuity, there are several factors that might affect its growth potential. Let’s talk about those below.
Cap Rates, Participation Rates, and Spreads
The insurance company generally sets a cap on the maximum interest rate that can be credited to your fixed index annuity, which limits your returns when the index performs well. For example, if the cap is set at 6 percent, and the underlying index gains 10 percent, you will only receive the capped interest rate of 6 percent.
Additionally, participation rates or spreads set by the insurance company can reduce the amount of growth you receive. However, all these factors are predetermined and disclosed in the annuity contract, which you can review before deciding if a fixed index annuity fits into your retirement portfolio.
Fees and Expenses
Like any financial product, fixed index annuities come with associated fees and expenses. These may include administrative fees, mortality and expense fees, commission fees, and more. Again, it's crucial to review the terms and conditions of the annuity contract to understand any extra fees or expenses involved. Some of these fees may be charged regardless of the underlying index performance, meaning that you may still be charged even during downturns when you aren’t earning returns.
Withdrawals and Surrender Charges
Before committing to a fixed index annuity, you’ll also want to carefully review your liquidity needs and reduce the risk that you might need to withdraw early.
Fixed index annuities are designed for long-term retirement planning, and they often have surrender charges if you withdraw more than a specified percentage of your contract value within a certain period—typically the first several years.
Get the Answers You Need About Financial Planning for Your Retirement
While fixed index annuities provide reassuring principal protection and the potential for growth, there are some limitations and factors that might impact your returns. If you have any questions, we encourage you to consult with a financial professional that can assess your financial goals, risk tolerance, and retirement needs.
At Leonard Financial Solutions, we want you to be able to make truly informed decisions about your financial future. When you work with us, you can rest assured that the options you choose align perfectly with your overall retirement strategy.