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Fixed Indexed Annuity Definition
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What Is An Annuity? Definition, Purpose, Types & Examples
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Fixed Index Annuity Guide: Suze Orman And Annuity
An index is a financial contract between you and an insurance company. It has features of both fixed and variable income.
Indexed annuities offer a guaranteed minimum interest rate combined with an interest rate tied to a broad stock market index, such as the S&P 500 or the Dow Jones Industrial Average.
This unique hybrid design can provide protection against stock market losses as well as the opportunity to profit from market gains.
Indexed annuities were created during the stock boom of the mid-1990s, when investors saw the potential for higher returns in stocks and were interested in stable, lower-yielding investments like bonds. . They are specifically designed to compete with certificates of deposit.
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After signing an indexed contract, the insurance company puts your money into the market index of your choice. You can choose one index for your funds or spread your dollars across multiple indexes.
In exchange for protection against losses, indexed annuities limit the amount you can earn, even in strong market years.
Therefore, these contracts are considered less risky than direct investment in the stock market, but they also offer lower potential returns.
There are several mechanisms used by insurers to determine the index change:
Deferred Income Annuity
It compares the change in the index from the beginning of the year to the end of the year. Rejections are ignored.
It looks at the value of the index at different points and takes the highest of the values and compares it to the initial level of the contract.
It compares the change in index rates at two pre-selected times. This can be the start and end of the contract period.
Some index annuities average the value of the index on a daily or monthly basis compared to the value on a particular date.
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Annuities also offer tax advantages. Interest earned within an index is tax-deferred. You won’t pay any state or federal income tax until the interest is deducted.
This is the percentage of your earned stock index that you . For example, if the participation rate is 80 percent and the index has a gain of 10 percent, 80 percent or 8 percent of the 10 percent gain will be paid.
Some index annuities include this instead of or in addition to the participation fee. This is the percentage that is deducted from any gain in the index. If the fee is 3 percent and the index earns 10 percent, it will earn 7 percent.
Some index annuities place a higher limit on your return. So if the index gains 10 percent and your limit is 7 percent, then the gain will be 7 percent.
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Index returns carry a so-called minimum return. Basically, this means that if you buy an index, you are guaranteed to receive at least a certain amount.
For example, if the stock loses 2 percent of its value over the next year and the guaranteed minimum rate is 3 percent, you will earn 3 percent.
If your index continues to perform, you have the potential to earn higher returns than traditional fixed income.
On the other hand, if the stock indexes tank, your payments will not go below the preset level. Guaranteed annual indexed minimums typically range from 1 to 3 percent per year.
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Indexed annuities are best suited for investors who don’t need the money right away. According to expert contributor Chip Stapleton, indexed annuities are most beneficial to investors who need 10 to 15 years of income, as they will have time to experience downturns that reduce income. .
Most indexed annuities prevent downside, says Stapleton, who is a FINRA Series 7 and Series 66 licensee and CFA Level II candidate.
“It can be zero-floor, so you don’t lose money,” he said. “But then your good is also limited, so if you want to limit your bad, you have to limit your good too.”
The market exposure of indexed annuities is downside protection, meaning these products have moderate risk. Stapleton recommends this type “for someone who is more risk averse but doesn’t want to be risk averse.”
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“You can design what you invest in to better fit your risk profile with your goals, your time horizon and your overall investment philosophy,” Stapleton says.
The case study below shows an example of how someone nearing retirement can benefit from the features of an index.
Hallie is nearing retirement and is looking for a way to secure income to supplement her Social Security checks.
He wanted to add some flexibility to the conservative side of his portfolio. He considered buying bonds, but was concerned that a large bond investment would not keep pace with inflation.
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An index is a good fit for someone like Hallie, because these annuities offer a low-risk way to generate predictable income. It is guaranteed not to lose money, so it is a less risky investment than a variable, which will lead to declines in the stock market.
“With an indexed annuity, you usually have fewer fees,” Stapleton says, “so if you’re fee-conscious but an indexed one can be a good choice.”
“Conservatively, these (indexed annuity) products are designed to return between 3 and 7 percent,” said Chris McDonald, director of sales and institutions for Senior Market Sales in Omaha, Nebraska. “However, we see higher than average returns, usually between 6 and 10 percent.”
Some investors choose indexed annuities over direct investment in index funds because of the tax advantages. Because annuities grow tax-deferred, you won’t incur any taxes until you withdraw the funds, unlike traditional investment vehicles like brokerage accounts.
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Another reason to choose an indexed annuity is the various benefits and features it offers. Stapleton cited examples like long-term care riders, death benefits and guaranteed income as advantages that make indexed annuities more beneficial for some people.
Like any investment, index annuities have their benefits and costs. Because they are essentially a hybrid of fixed and variable annuities, they have a mix of pros and cons. They have the potential for higher profits without the risk of losing your money. Because these annuals are complex, they can be difficult to understand.
Wendy Swanson, RICP®, CLTC®, NSSA® | 2:47 What is the difference between fixed index and other types of income?
Indexed annuities are just one of three main types. The other two are fixed and variable income.
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Fixed annuities are not linked to stock market performance. The interest rate is set in your contract at the time of purchase and does not change. The funds are therefore guaranteed to grow at the same rate over a specified period of time.
With an index, the amount of payments made to the owner can increase if the predetermined stock index performs well.
Annual variable interest rates vary
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