A fixed indexed annuity, or FIA, is a deferred annuity issued by an insurance company. Your interest is linked to the performance of a market index such as the S&P 500, but your money is not invested in the market. In exchange for giving up some upside, the contract limits losses according to its terms. That sounds attractive, so it deserves careful reading of how the pieces work.
The basic idea
You deposit money with the insurer. Each contract year, the insurer measures the change in the chosen index and credits interest using a formula. If the index falls, the credited interest is generally zero rather than negative. This is often called a floor. The trade-off is that the credited gain is limited by one or more crediting limits.
The three limits that matter
- Cap rate. The maximum interest you can earn for a period. For illustration only, imagine a hypothetical cap of 5 percent. If the index rose 12 percent, you would be credited 5 percent. If the index fell 10 percent, you would be credited zero.
- Participation rate. The percentage of the index gain that counts. With a hypothetical 60 percent participation rate and an index gain of 10 percent, you would be credited 6 percent.
- Spread (or margin). A percentage subtracted from the index gain before crediting.
These numbers are set by the insurer and can change, often annually, on non-guaranteed portions. Always ask which are guaranteed for the life of the contract and which can be adjusted.
Surrender charges and liquidity
FIAs are designed to be held for a period, commonly several years. If you withdraw more than the free-withdrawal amount during the surrender period, a surrender charge can apply, often declining each year. Withdrawals before age 59½ can also be subject to an additional 10 percent federal tax. This is a long-term product, not a place for emergency money.
Riders and fees
Some FIAs offer optional income riders that promise a guaranteed lifetime income amount, sometimes with a rider fee. Pay attention to:
- How the rider's income base grows, and that it may differ from the account value.
- The annual rider charge.
- When income can begin and how payments are calculated.
- Whether the rider can be changed or removed.
The income base is often not a cash value you can withdraw, and confusing the two is a common misunderstanding.
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Request my Retirement Income ReviewWho an FIA may fit
- Someone near or in retirement who wants some growth potential without direct market losses.
- Savers who are comfortable leaving the money untouched for the surrender period.
- Buyers who value contractual guarantees and understand the limits on upside.
Who should be cautious
- Anyone who may need the money soon.
- People who expect to capture most of the stock market's gains.
- Buyers who have not read the cap, participation, and spread terms and the surrender schedule.
- Anyone being pressured to move money quickly.
Tax basics
Growth inside a non-qualified FIA is tax-deferred, but gains are taxed as ordinary income when withdrawn. Qualified money such as an IRA is generally fully taxable on distribution. Read how annuities are taxed and consult your tax professional.
How an FIA compares
An FIA generally sits between a savings-type product and market investments in risk and reward. It differs from a single-premium immediate annuity, which focuses on income, and from a CD, which is FDIC-insured and has fixed terms. Each has a different role.
Questions to ask
- Which crediting limits are guaranteed and for how long?
- What is the surrender schedule and free-withdrawal rule?
- What fees or rider charges apply?
- What is the insurer's financial strength?
- How is the recommending agent paid?
What the sales illustration will not tell you
Illustrations usually show a smooth, favorable path based on assumptions about index performance. Real index returns are uneven, and credited interest in a year with strong market gains can still be limited by the cap. Ask for illustrations that use lower and zero-return scenarios, and look at what happens to your account value and your income rider if the market is flat for several years. A good product still looks acceptable under conservative assumptions.
How we help
We are an independent agency. We explain how FIAs from multiple carriers work, in plain English, and we do not promise returns. Request a review if you want a second set of eyes on an illustration before you decide.
Availability and rules vary by state
Life insurance and annuity products, rates, riders and consumer protections differ by state, and a given product may not be available in every state. Honorbrook is licensed in the 11 states below; which products we can offer you depends on what carriers sell in your state. Each state’s insurance regulator can verify an agent’s license and answer consumer questions.
- Virginia: Virginia Bureau of Insurance
- Maryland: Maryland Insurance Administration
- North Carolina: North Carolina Department of Insurance
- South Carolina: South Carolina Department of Insurance
- Georgia: Georgia Office of Insurance and Safety Fire Commissioner
- Alabama: Alabama Department of Insurance
- Louisiana: Louisiana Department of Insurance
- Texas: Texas Department of Insurance
- Michigan: Michigan Department of Insurance and Financial Services
- Indiana: Indiana Department of Insurance
- West Virginia: West Virginia Offices of the Insurance Commissioner
This article is general information and is not tax, legal, investment or financial advice. Annuity guarantees depend on the issuing company’s claims-paying ability, and surrender charges and fees may apply. A licensed agent can help with your situation.