Fixed Index Annuities (FIA)
Fixed index annuity is an equity-indexed annuity that earns interest or provides benefits that are linked to an external equity reference or an equity index. The value of the index might be tied to a stock or other equity index. One of the most commonly used indices is Standard & Poor’s 500 Composite Stock Price Index (the S&P 500), which is an equity index. The value of any index varies from day to day and is not predictable. When you buy an equity-indexed annuity you own an insurance contract. You are not buying shares of any stock or index.
Source: National Association of Insurance Commissioners
FIA policies will charge fees for the first five to 10 years if you cancel the policy. This is called the “surrender period.” After the surrender period, there are no charges to withdraw a portion or all of your funds.
Some annuities determine interest by a spread. For instance, if an FIA has a 4% spread and the index increases 10%, the contract is credited 6% interest.
Some FIA contracts offer a specified, minimum amount your policy will be worth, regardless of index performance, called a “floor.” Other contracts may include a “cap,” or maximum amount of growth, regardless of how well the index on which the contract is based performs. Uncapped policies are also available, offering you unlimited potential growth.
With some FIAs a specific percentage is given relative to an index’s performance. For instance, if the participation rate was 75% and the market rose by 10%, the contract would receive 7.5% in indexed interest. This is generally applied after caps and before a spread.
In general, there are two ways to receive income payments from an FIA—annuitization payments or income withdrawals. There are different tax ramifications for each option, so it is important to get tax advice from your accountant or qualified tax professional before choosing a payout method. You may extend the amount of income you receive through the purchase of an optional income rider to the FIA.
Because FIAs don’t directly participate in any stock or equity investment, an FIA’s value will not be affected by negative markets, sometimes called “downside protection.” On the other hand, if the index has a positive return for the year, the FIA policy is credited with interest—sometimes called “upside potential.”
Each FIA policy has a formula for the way interest is calculated and credited that falls into four basic categories:
- Annual reset – Adjusts the policy floor based on the change in the market index over a
specific period of time.
- Point-to-point / term – Similar to the annual reset, but the period is usually five to seven years.
- Annual high-water mark with look back – Typically uses the highest anniversary value to determine the gain.
- Monthly averaging – Measures the index performance once a month on a specified day, and then at
the end of each year, the insurance company adds them up and divides by 12.
Through optional riders, fixed indexed annuities offer features which can be added to FIA policies for additional fees, allowing customization based on individual need. For instance, one popular rider with retirees is the lifetime income option, meaning the annuity will keep paying you a certain amount of income throughout your lifetime, regardless of how long you live. Other riders include a guaranteed death benefit for beneficiaries, long-term-care coverage, future cost-of-living or inflation adjustments, joint or spousal survivorship, and surrender charges waived for disability, unemployment or terminal illness. Each policy is different, and insurance companies offer varying stipulations and coverages as they compete and improve their policies and riders based on consumer demand.