An insurance product that allows your savings to grow in a tax-deferred manner is what a fixed index annuity is. The growth of your savings is linked to a stock market index, while your downside is limited that makes the key differentiator of a fixed index annuity from other types of annuities.
The Upside Limitations
The return of a fixed index annuity is linked to a stock market index during an annuity’s accumulation phase. The commonly used example of stock market indexes is the Dow Jones Industrial Index, the S&P 500 Index, and then the Russell 3000. For fixed index annuities, the disadvantage of it is it is limited in such a way that you are guaranteed not to lose your original principal. The annuity’s growth is subject to spreads, caps, and participation rates in many cases. With this features, it modifies how changes in the stock market index impact the growth in your savings.
The Tax Deferral
Tax deferral is another key feature of a fixed index annuity. It only means that any growth in your savings is not taxed until the money is withdrawn. You will save significantly on taxes if your tax rate when you withdraw money is lower than your tax rate today. You can a look at the ultimate guide to tax deferral for more info for an in-depth examination of tax deferral and whether it can potentially save you money.
The Criticism Of Fixed Index Annuities
Fixed index annuities also have an opposing reputation amongst personal finance mentors and commentators. This is the criticism that is driven by the following observations:
- They pay high commissions which can be 5% to 10% of your money to agents or brokers.
- It’s hard to know what returns an investor should expect because of they are complicated like the caps, participation rates, annual point-to-point, spreads, etc.
- They have vertical surrender charges that’s why they aren’t liquid.
- These carriers can change the rates or rules yearly at their will.
For the most part, these criticisms are legitimate. The fixed index annuity has been more of an agent/broker-friendly product than a customer-friendly product. A fixed index annuity does seem magical, as for the positives, and its value proposition of providing some market upside with no downside seems almost too good to be true. Nevertheless, they are still sold by highly commissioned agents/brokers who may not have your best interests at heart. The steep commission is also the root cause for why the surrender charges on them are not customer-friendly. Also, the complication of the annuities makes it easier for customers to misunderstand what they are actually receiving when they hand over their hard-earned money to an insurance company.