What is a Fixed Index Annuity (FIA)?
The Annuity Man
The hottest “sounds too good to be true” and “best thing since sliced bread” product to hit the financial world in the past few years is the Fixed Index Annuity (FIA). Regardless of your specific financial goals, some agent or financial advisor will most likely pitch you this product…so it’s important to know the factual reality before someone sells you “the dream.”
For the record, I often recommend FIAs when they are suitable and appropriate. However, I use them differently than most agents and only present them for their contractual guarantees. That makes me very unique in the annuity world.
First of all, FIAs are fixed annuities. They are contracts issued by life insurance company, and not a security. You only need a state life insurance license to sell them. You only have to score a 70 on most state exams to pass. In other words, the qualification bar to sell FIAs is very low. I really wish that would change, but it probably never will.
FIA History Lesson
FIAs were first designed and introduced in 1995 to compete with CD returns. Since that time, those are the exact historical return numbers that FIAs have produced. In my opinion, principal protection with CD (or a little better) returns is a good thing. That fact flies in the face of the typical FIA sales pitch of “stock market upside with no downside” or “market participation with principal protection.” Those 2 sales carrots are factually wrong, but used across the country at bad chicken (or expensive steak) dinners where FIAs are the main course. As I have said for years, if you could get consistent market returns (which you can’t) with FIAs....that’s all the FED should buy.
So do I hate FIAs? No! I just hate the way that too many of them are sold. FIAs are a tax deferred CD product that protects your principal. I have no problem with that, and you shouldn’t either.
700 + 40 = TOO MANY
The return portion of the FIA product is where the misleading sales pitches proliferate. FIAs typically use a call option on an index (typically the S&P 500), and limitations (i.e. caps & spreads) are placed on those potential gains. The majority of FIAs lock in the hopeful gain only on the contract anniversary date, and those index option choices can be changed every year at the discretion of the carrier. It’s important to point out that over half of the historical returns of the S&P 500 are from dividends….but dividends are NOT included with FIA call option strategies.
A current trend is for carriers to use algorithms to back-test for a specific return, and then create an index name to use with their FIA. This is a bad practice in my opinion, and many states are trying to legislate this from happening.
Currently, there are over 700 index call options available with FIAs and over 40 index choices (some made up out of thin air). Each carrier and product has different and limited choices with each product. No FIA is better than the other one in my opinion. The FIAs limited return is based on the performance of an index, but those limitations (i.e. caps, spreads, participation rates) offered by the annuity carrier can be changed by that company at their discretion.
But here's the good news. If the index performs well, then your return is permanently locked in on the contract anniversary date. If the index is negative for the year, you don’t lose money. FIAs never participate in market volatility, which is a true contractual benefit.
FIAs also have surrender charges that are very high during the lock in period. Those lock in time frames can be as short as 4 to 5 years and up to 10 or more years.
Once again, FIAs are fixed products issued by life insurance companies that fully protect the principal and produce CD type (or a little better) returns. Losing money is never a good thing, and FIAs will fully protect you from that ever happening.
Efficient Delivery System
At the time of application, you can choose to add an “Income Rider” to the policy for future lifetime income stream guarantees. This is how I primarily use FIAs with my clients. Income Riders are a separate calculation from the accumulation value (i.e. walk away amount), and can only be used for income. Income Riders can’t be liquidated or transferred. The interest rate portion that some Income Riders offer during the deferral time period can’t be peeled off like real interest products (i.e. CDs, Bonds).
For “Income Later” type quotes for future pension income guarantees, I recommend quoting both Income Riders and Deferred Income Annuities (DIAs) for the highest contractual guarantee for your specific situation.
NO FIA Philanthropists
Too many FIA sales pitches would make you believe that annuity company CEOs are philanthropists. I know a lot of them and they are nice people, but they don’t give anything away. Annuity companies have the big buildings for a reason.
Many FIAs offer an upfront signing bonus. That sounds like free money, but it isn’t. Upfront bonuses are just part of the overall contractual guarantees of the policy. Nothing more. Just because a Fixed Index Annuity offers an upfront bonus doesn’t mean that that “bonused product” will produce the highest contractual guarantee. In most cases, it does not.
Don’t Be A Rube...Be Informed
As they say in Vegas, if you don’t know who the rube is at the table...then it’s you. Don’t be that rube buying the dream, because you are going to own the contractual realities. The bottom line is that if it sounds too good to be true, it is every single time…without exception…when it comes to FIAs. Fixed Index Annuities are enhanced CD products. Pure and simple.
Currently, Fixed Index Annuities (FIAs) are the best selling annuity type in the country. If you are interested, then do your homework. Ask for specimen policies before signing the paperwork. Write down exactly what the agent pitched and promised during their presentation in detail. Sign and date that document at the bottom, and then have the agent sign and date it as well.
In my opinion, the best way to use FIAs is to purchase them for the Income Rider if you need future income guarantees. This allows you to retain full control over the asset, yet have a personal pension plan in place.