What is a fixed-index annuity?

A fixed-index annuity is a relatively new financial option offered by insurance companies. It was created in 1994 as an alternative investment to stocks, mutual funds, and CDs.

When you invest in a fixed-index annuity, you get the attractive features of tax-deferred growth and a guarantee that you will not lose any of the money you put into the annuity or the gains.

Our money is safe

Today, there is a surge of interest by life insurance companies to get into this lucrative market. Many companies that once only offered variable annuities are now offering fixed-index annuities as an option to their clients.

Unlike variable annuities that invest in different mutual funds, the performance of fixed-index annuities are tied to a single index such as the S&P 500 Index.

Stock market alternative

Older individuals who are nearing retirement may be hesitant to put their retirement savings at risk in a volatile stock market. They do not have the luxury of time to recover from big losses in the market.

Even those who are younger may be risk averse after the historic bear market that lasted for almost 18 months (October 2007-March 2009).

Mutual fund alternative

You get diversification through a mutual fund or group of mutual funds, but that does not protect you in a declining market environment. While mutual funds are less risky than owning an individual stock, you can still lose a lot of money in a bear market environment. You need only go back about 5 years to see that employee 401K plans, which typically consisted of mutual funds, dropped in value by more than 30 percent.

CD alternative

A certificate of deposit is a very safe investment, but in today’s low interest rate environment, where the 10 year Treasury Bill is paying well below 3 percent, CDs are paying less than half of that amount. With a fixed-index annuity, you are usually guaranteed a minimum rate of return; and if the underlying index does well, you can earn a substantially higher return on your investment.

Money that you cannot afford to lose should not be put at risk. A fixed-index annuity is a suitable stock market alternative or mutual fund alternative for anyone who has the goal of preservation of capital.

When you buy this type of annuity, your contractual agreement will guarantee that you will never lose a dime of what you invested and will also usually have a minimum interest rate that you earn each year while you hold the investment.

Making the extra money you want and need

A fixed-index annuity is similar to a CD in a retirement account without the potential to double, triple, or increase your interest rate by even more in a year. In addition to the base interest rate you earn, you can participate in the positive returns of the index.

While you typically only receive about 75 percent of the increase over the course of your investment year (a one-year period that starts from the day you purchase the annuity), that can still make a substantial difference in your earnings for that year. You may also have a cap on the maximum amount of extra interest you can earn based on the performance of the index.

One of the best features of a fixed-index annuity is that you do not lose any money in a year when the stock market and/or index fall. So, if you are tied to the S&P 500 Index, and the stock market is down by 15 percent in one year, your interest for that year is the guaranteed minimum.

Which way will the market go next?

While a fixed index annuity is not appropriate for everyone, it does make sense for people who want to invest in the stock market at a low risk. In good markets, you will not earn as much as an index fund outside of an annuity, but in bad or bear markets, you will still have all of your money safe.

John Ziesing

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