What is a Fixed Index Annuity

Annuities are varied financial products that provide financial benefits for annuitants in exchange for contributions. The Fixed Index Annuity (FIA) – also known as equity-indexed annuity- is a type of fixed annuity. While it is equity-indexed, the FIA is not essentially an investment product but an annuity contract with an annuity provider/ insurer.

The FIA combines safety with growth through participation in market-indexed returns. As a fixed annuity, FIAs do not bear the risk of premium loss by participation in securities. They differ from other fixed annuities because the rate of return fluctuates frequently as opposed to more stable fixed annuities.

Fixed index annuities link to performance of select securities through a market index. This combination of securities allows the fixed annuity investor to benefit from a diversified retirement savings account. The actual rate of return follows the changes in a market index (such as the S&P 500). However, it does not mirror the market index precisely since annuity providers may issue lower returns than the index stipulates.

Annuity providers determine the fixed index annuity’s rate of return in a number of ways:

Participation rates: This rate determines how much the change in the index affects the annuity’s performance. For example, 75% participation in an index that falls by 5% yields a drop in the annuity’s rate by 3.75% (0.75 x 5%).

Interest rate caps: Limits to the earning potential of an equity-indexed annuity. Annuity providers normally state the interest rate caps in the annuity contract.

The Margin Fee (also known as the Spread or Administrative Fee): This is what the annuity provider subtracts from the index returns.

The indexing method has a major impact on returns as well. An equity-indexed annuity has three basic methods- based on the treatment of index increases- to determine how returns are applied:

i) Point to point
ii) High water mark
iii) Annual reset

Although Fixed Index Annuities insulate the annuity investor against market loss, premiums can still be ‘lost’ to the insurer through withdrawal fees and surrender charges. In addition, the guaranteed amount on a FIA may be less than accumulated premiums. It usually takes several years for the guaranteed amount on most annuity contracts to match and surpass the accumulated premiums.

As normal annuity contracts, fixed index annuities may provide tax incentives once they are qualified or registered. Other benefits include provision of guaranteed lifetime income and market-indexed performance that helps to overcome inflation risk in annuity investment plans. The demerits of FIAs are the demerits associated with annuities in general. However, annuity investors should not be duped into thinking that their full amount is guaranteed in a particular fixed index annuity contract.

Fixed Index Annuities seek to provide the safety of annuity contracts with market-type returns. However, not all Fixed Index Annuities are the same. You must assess each contract with an insurer to determine how well it can fit your retirement plans and ambitions.