Ask the Hammer: Should I Invest in a Fixed Index Annuity?

Robert Powell, CFP®

Are you interested in investing in a fixed index annuity? What are the features and benefits of what some call an FIA? What the pros and cons? That's what a reader wanted to know in this episode of Ask the Hammer with Jeffrey Levine, director of advanced planning at Buckingham Wealth Partners.

Here's are the highlights of what Levine had to say.

First, there are many different types of FIAs. So, you have to look at your exact product to understand the exact benefits and exact drawbacks. Read Indexed Annuities | and Updated Investor Bulletin: Indexed Annuities |

In general, however, there are two parts to a fixed index annuity: the accumulation phase and the annuity phase. According to the Securities and Exchange Commission (SEC), during the accumulation phase, you make either a lump-sum payment or a series of payments to the insurance company. And, you can allocate these payments to one or more indexed investment options. The insurance company credits your account with a return that is based on the indexed investment option’s return.

One benefit of a fixed index annuity? It provides principal protection, according to Levine. 

How your returns are calculated, however, vary from FIA to FIA. And two factors that could affect an FIA's return are 1) its participation rate (how much of the gain in the index will be credited to your annuity) and/or 2) its rate cap (the maximum rate of positive return that your contract can earn). 

"It's about knowing your specific product," said Levine. 

So, what are the drawbacks? Are these FIAs good or bad? "They're not good nor bad," said Levine. "They are. For some people, they're worthwhile as having as a part of a portfolio, particularly as a bond replacement vehicle. For others, it's not a good fit."

The issue with fixed indexed annuities is, says Levine, less with the "products themselves" and more with the way that they're positioned or sold by those dealing with them in particular. "You often hear 'you have no market risk, but you get the market upside,'" he says. "That is not true."

Another drawback: You may have to pay a surrender charge if you take all or part of your money out during the surrender period, which could be six to 10 years, or even longer. And there are FIAs with what Levine describes as "egregious surrender schedules," surrender periods of 15 years to 20 years until you can get your money without a penalty.

And given all that is so unpredictable in life Levine recommends being "very cautious about how long you tie up your money for unless you are absolutely 100% sure you won't need it."

Levine's bottom-line advice when it comes to FIAs is this: If it sounds too good to be true it probably is. "And that would absolutely apply (with FIAs)," he says. "So, first never assume you're going to get market-style returns. It might happen based on your particular annuity and based on what the market does, but it is highly, highly unlikely."

Instead, he says, you should think of FIAs as a fixed-income replacement in your portfolio. 

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