Fixed Index Annuities as Retirement Tools: Pros and Cons
With so many fixed index annuity products available, each with its own contract terms and varying rates, it's crucial to invest in an FIA that fits your retirement plan.
As the retirement population continues to grow, millions of pre-retirement and retired Americans are turning to various annuity products to bridge the financial gap between what they have and what they need. Fixed index annuities (FIAs) are insurance contracts that provide retirement income.
Growth in an FIA is based on the performance of a stock market index, such as the S&P 500. However, unlike stocks, your principal investment is protected against market fluctuations, although there are caps on gains. In this article, we'll discuss how FIAs can be used as retirement tools and what to watch out for as you educate yourself on FIA features.
Fixed index annuities have a checkered past
FIAs have come a long way since they were considered high-risk financial products two decades ago. Nowadays, certain types of income annuities have even been endorsed by the U.S. Treasury as viable tools to bolster retirement income. However, annuities with terms over 10 years have been banned in many states.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
With so many FIA products available, each with its own contract terms and varying rates, it's crucial to invest in fixed index annuity that fits into your retirement plan based on contractual guarantees, rather than hypothetical projections. Some annuity products are designed for growth, while others are designed to generate retirement income. The best retirement plans offer practical options to handle stressors that threaten your savings or peace of mind, instead of just hoping for the perfect scenario.
As you approach retirement, you naturally gravitate toward guaranteed and stable income. During the accumulation phase of your FIA, your money earns interest based on the performance of the index it's associated with. Your premium is determined by that index's performance, but your funds are not directly invested. This means your funds can benefit from strong index performance over time without being depleted if the index goes down.
Here’s where nine out of 10 pre-retirees say they would purchase an FIA based on this feature alone.
Not so fast. The “catch” could be in the fine print if you don’t fully understand all the other features of your FIA:
- What are the fees for this particular product?
- What’s the surrender charge for early withdrawal?
- How long are the rates contractually promised to you?
- What kind of riders are available, and how might they benefit you?
This last point is especially important. The number one piece of advice we give our clients is to not pay for anything they aren’t going to use. For instance, it doesn’t help to pay for an income-increase rider if your funds are already healthy enough to sustain you through your retirement years. Perhaps something like a long-term care enhancement to double your income in the event you end up in a nursing home would be more practical. FIAs are as varied and unique as people are — we’ll help you determine which features serve your situation best.
When FIA products mature matters
Here’s something to consider. When you’re allowed to withdraw funds without surrender charges depends on the contract, which varies from product to product and company to company. It’s very important you pay attention to this time factor. You don’t want to be a 65-year-old purchasing a product that takes 10 years to mature. Be sure that you’re thinking realistically about the lifetime of your FIA, your age and life expectancy in your family (and your spouse), and that you accurately plan for health costs.
Now that you have invested funds in your FIA, you can start receiving income during your retirement. But how do you go about it? Most FIAs offer the flexibility to decide how you want your money to be allocated. Are you someone who needs to pay off debt before passing it on to your loved ones? Then a one-time lump-sum payment may benefit you.
Or perhaps you, like most retirees, need a reliable income stream and want monthly payments for life.
Some people benefit from taking out specific amounts of money at particular intervals, such as helping to pay for their grandchildren's tuition or paying fees at a retirement community.
Choosing how your funds will be distributed is as important as understanding the contract itself.
The bottom line
Annuities are a versatile retirement tool that can help you accumulate money for retirement, grow your investment on a tax-deferred basis and give you a guaranteed income stream for life. But it’s important to understand that FIAs are as different as people are — you have to find the one that’s right for you.
Bear in mind that FIAs are a piece of a viable retirement plan, not the whole plan.
No need to take our word for it. Sit down with a financial professional to decide if an FIA is right for you.
Related Content
Get Kiplinger Today newsletter — free
Profit and prosper with the best of Kiplinger's advice on investing, taxes, retirement, personal finance and much more. Delivered daily. Enter your email in the box and click Sign Me Up.
Cliff Ambrose, the visionary behind Apex Wealth, serves as a wealth manager with an innate passion for steering individuals toward enriched financial independence. His journey began with a robust educational foundation in finance and economics, culminating in a degree that set the stage for his financial guidance career. With his start at Metlife, Cliff acquired valuable hands-on experience in the industry, complemented by securing his Series 6 and Series 63 licenses and, later, his Series 65 qualification.
-
Need More Money for Retirement? You May Have Already Saved It.
Over 29 million lost 401(k) accounts worth almost $1.65 trillion have been forgotten by their owners. Here are eight ways you can locate your account.
By Donna LeValley Published
-
Five Ways to Save for Retirement in 2025
If you did a poor job saving for retirement last year, don't despair. There are ways to build your nest egg in the new year.
By Donna Fuscaldo Published
-
Late to the Retirement Savings Party? Five Tips for 2025
If you did a poor job saving for retirement last year, don't despair. There are ways to build your nest egg in the new year.
By Donna Fuscaldo Published
-
The Wrong Money Question to Ask After Trump's Election
If you're wondering what moves to make with a new president moving into the White House, you're being dangerously shortsighted. Here's what to do instead.
By George Pikounis Published
-
An Investing Plan for This Year: Doing Less Can Lead to More
Achieve more when investing in 2025 by planning to work smarter, not harder. These three strategies can help put you on the right track and keep you there.
By David Booth Published
-
All About Six Types of Auto Insurance Coverage
Do you know what your auto insurance policy covers? Here's a primer on some coverage categories, along with examples of how each type of coverage works.
By Karl Susman, CPCU, LUTCF, CIC, CSFP, CFS, CPIA, AAI-M, PLCS Published
-
10 Reasons to Leave Your Heirs a Roth IRA
Including a Roth IRA in your estate plan has clear tax advantages, which can be passed along to your heirs for years to come. But if passed down incorrectly, your heirs won’t reap the full benefits.
By Kathryn Pomroy Published
-
The Cheapest Places To Retire in the US
When you're trying to balance a fixed income with an enjoyable retirement, cost of living is a crucial factor to consider.
By Stacy Rapacon Published
-
The Best Bank ETFs to Buy
The best bank ETFs can offer above-average yields and reduce the complexities of investing in financial stocks.
By Tony Dong, MSc Published
-
Social Security and Medicare Funding: Is the Sky Falling?
Social Security and Medicare are slowly running out of money, but what does that mean for the retirees counting on them? Actually, it's not all bad news.
By Jared Elson, Investment Adviser Published