All financial products possess their own unique characteristics. Fixed indexed annuities (FIAs) are no exception, and have specific advantages over other financial products. From protection against market loss and higher growth potential, to more flexibility with contributions and receiving payments, here are some important advantages to consider when comparing fixed indexed annuities with other popular financial products.
Bonds
Bonds are loans taken out by companies or governmental institutions. Instead of going to a bank, the borrower gets money from investors, who they promise to reimburse and pay interest in the interim. Interest payments are based on the bond’s annual rate, and issued over a finite time period. The interest paid is a percentage of the loan’s face value, and usually issued on an annual or semiannual basis. The bond “matures” at the end of this fixed time period, after which the initial lump sum is returned to the lender.
One of the biggest advantages fixed indexed annuities have over bonds is the lack of risk exposure. While FIA interest rates can fluctuate, you’re still protected against market losses, and can never lose money. Not only are bond prices inversely proportional to interest rates, but since they essentially are loans, it’s possible the borrower can default on their debt. When that happens, you lose 100% of your investment. Although these instances are rare, bond defaults are becoming more frequent, and expected to continue rising. Fixed indexed annuities have no such risk exposure, since they’re tied to stock market indices, and not an actual institution.
Certificate of Deposit
Certificates of deposit (CDs) are savings products that earn interest on a lump sum of money over a fixed period of time. That money must remain untouched, otherwise the owner may incur penalty fees or lost interest. Details like a CD’s timeframes, rates, and penalties are usually determined by the issuing financial institution. When the CD matures, you can either roll your funds into a new certificate, transfer them to another account, or make a full withdrawal.
As previously stated, you cannot withdraw from your CD for the entire term without getting penalized. If you’re aged 59 ½ or older, you can make withdrawals from fixed indexed annuities after a certain period of time passes (depending on your contract’s terms). Although both are among the most secure investments you can make, CDs usually generate lower returns than FIAs. CDs are also essentially short or medium-term investments, whereas FIAs are designed for long-term use – more ideal for retirement planning.
CD earnings are based on benchmark interest rates. This means you run the risk of your investment falling behind the rate of inflation, which could make your money lose its purchasing power. One of the biggest differences between CDs and FIAs, however, is taxation. Even if you don’t make any withdrawals, the earnings your CD generates are taxed as interest income. FIAs on the other hand, grow tax-free. Depending on your type of fixed indexed annuity, you can even make tax-deferred contributions or receive tax-free payments.
Individual Retirement Account
Like fixed indexed annuities, individual retirement accounts (IRA) are a type of retirement savings account with certain tax advantages. You can make annual IRA contributions up to a certain amount each year, and they offer a variety of investment options from stocks and bonds, to mutual funds or CDs. You are, however, discouraged from making withdrawals before age 59 ½, and will face a stiff penalty, unless it meets one of a few exceptions. IRAs have two main types – Traditional and Roth. Traditional IRAs let you make tax-deferred contributions, whereas Roth IRAs allow you to make tax-free withdrawals.
Despite the different investment options IRAs offer, you run the glaring risk of losing money if the market goes south. As previously mentioned, a fixed indexed annuity can never go down, and offers guaranteed protection against market losses. One of the biggest drawbacks IRAs have are their annual contribution limits of $6,000 ($7,000 if you’re age 50 or older). IRAs also have income-based restrictions on tax-deductible and annual contribution limits. If you make above a certain amount (depending on the type of IRA), you’re ineligible for tax deductions or even making contributions. You also need earned income to even open an IRA. Fixed indexed annuities have no restrictions based on income or contribution limits. While FIAs and IRAs both discourage early withdrawals, IRAs require you to make minimum withdrawals after age 72. Unless it’s held within an IRA or 401(k), FIAs have no such requirements, and allow you to begin receiving payments when you decide.
401(k)
401(k)s are offered by employers, and considered one of the most popular types of retirement accounts in the US because of their tax advantages. Employees who sign up for 401(k)s agree to have a percentage of each paycheck deposited directly into their account. The employer may partly or fully match that contribution, but almost all employers limit how much they’ll match. 401(k)s offer a limited number of investment options, and like FIAs, they encourage Americans to save long term for retirement.
Like IRAs, 401(k)s offer investment options that run the risk of losing money, they require minimum distributions starting at age 72, and have annual contribution limits. Fixed indexed annuities have none of these drawbacks. Most employers who even match 401(k) contributions cap them at five or six percent of your weekly salary. Although over 80% of employers who offer 401(k) plans match at least a portion of contributions, less than 30% let employees immediately take full ownership of their matches until a certain amount of time passes (which can usually take years). If you leave the company beforehand, you’ll lose every penny of those withheld contribution matches. Although FIAs discourage early withdrawals, you’re guaranteed to, and have complete ownership of the funds in your account.