An annuity is an insurance contract between a person and a financial service provider. The agreement mandates that in return for payments made in the present, the company will pay the individual in the future. It can be likened to insuring your savings today in exchange for regular payments down the line. Additionally, the money you save is invested by the financial company. So you save, earn returns, and get paid in the future.
There are two types of annuities, variable and fixed, and here’s the major difference between them: variable annuities have a fluctuating rate of increase while fixed annuities offer a fixed return on investment (ROI). Simply put, the former lets your investment grow (or shrink) as much as the market allows, and the latter has a fixed rate, regardless of whether the market rises or falls.
A fixed index annuity (FIA) combines features from the fixed and variable options. The fund is tied to an index fund like the S&P 500, and subscribers get a minimum guaranteed interest rate. This protects your capital when the market is going through a downward cycle, and ensures you benefit maximally from market gains. For people looking for smart ways to maximize their income/savings, fixed index annuities may provide the following benefits:
It’s a proven way to grow capital while deferring taxes
Perhaps the most interesting feature of fixed index annuities is that contributions are made tax-free. This is followed closely by the fact that you can save as much as you want, with no restrictions. The two points listed above make FIA a direct alternative to individual retirement accounts (IRA) and 401(k)s.
Not only can you save as much as you can spare, you also get to defer taxes until you start making withdrawals. This means you can start saving in your 30s and 40s, accumulate capital (+ profits) for over 20 years, then get a regular income for the rest of your life.
Your capital can grow in tandem with the stock market
Unlike retirement accounts that often have conservative ROIs, fixed index annuities let you make the most of good stock market years. Your returns are based on the performance of an external index, and you may choose to be aggressive with your investments to maximize gains. Now, here’s the best part: during down years, your capital is protected because you have a minimum guaranteed rate (usually 0%). So, you enjoy the best days of the stock markets, but do not suffer on its worst days.
It can provide a regular stream of income for retirees
Fixed index annuities have an accumulation phase when you can contribute to your account but can’t withdraw. This, along with the insurance contract that mandates you get paid in the future, makes it a good retirement account. You can save up just like with 401(k)s, earn returns, and get steady withdrawals after you clock 60 years.
And since it’s tax-deferred, you earn returns on your capital, the interest you accrue on the account over the years, and any taxes you should have paid. At the end of the accumulation phase, you get a nice little nest egg that’ll provide steady income when you retire.
You can tailor future income to meet your needs
If you earn a certain amount of money today, you can estimate how much you’ll need for the future. To be on the safe side, you may factor in health emergencies and miscellaneous expenses. It’s important to make this estimate because your financial provider will ask when you want the payments to start and how long you want them to last for.
This information can be used to approximate how much you need to contribute now to have enough saved up for the future. So, if you know how much income you’ll require, you can deduce the amount you must contribute today to get enough to meet your needs. Now, here’s another interesting nugget about fixed index annuities, you can pay a lump sum if you don’t want to make monthly contributions.
The fund is off-limit to creditors
Just like conventional retirement accounts, your savings cannot be garnished in the event of your passing. If, by the time of death, an account owner has not exhausted their savings, beneficiaries get the rest of the money. And survivors don’t need to wait for the notoriously slow probate courts. They can work with the provider outside the courts to claim their inheritance. Of course, this situation could be avoided if you plan your estate ahead of time.
Conclusion
Fixed index annuities can be a good option for people who want to grow their retirement savings at a faster pace than IRAs or 401(k)s. If you didn’t start contributing to your retirement early because of financial constraints, but your outlook has improved, you can leverage variable annuities to make up for lost time. Additionally, if you have maxed out your retirement contributions, FIA lets you put more money aside for the future. There’s no limit to contributions, payments to the account are made tax-free, and you can make significant gains from the financial markets.
Of course, it comes with some downsides. Return caps and participation rates may reduce how much profits you can earn. Also, fixed index annuities typically have high management fees, and the IRS may charge a 10% penalty fee if you try to withdraw during the accumulation phase.
However, there are ways to minimize these disadvantages and make the most of fixed index annuities. To learn more about maximizing this unique type of retirement investment account and get answers to any questions you may have, schedule a FREE consultation with our in-house specialist using this link.
