Fixed Index Annuity Allows Market Participation With Safety
Traditionally, annuity purchasers were restricted by one of two types of annuity purchase. This limited their choices to either a fixed annuity or a variable annuity. The fixed annuity has allowed stability and consistency in the market, and the variable annuity has allowed the more adventuresome investors the ability to participate in the markets with their annuity product. In the Mid 1990s a third option was introduced by insurance companies that combined the best attributes of both fixed and variable varieties. This product is known today as the fixed index annuity.
A complaint that many fixed annuity owners had regarding their product is that it was limited by the set parameters of the product and didn't not participate or even benefit from growth years in the markets. Correspondingly, the major complaint of variable annuity owners is that while the product allowed market participation, it was altogether easy to lose your hard-earned annuity dollars. Variable annuities were often too risky for the average investor, and had been (and are) exploited by overzealous financial planners.
Fixed index annuities were a way for the insurance companies to provide a fixed annuity product and allow for a degree of market participation at the same time. They found that many investors wanted the safety of fixed and the upward market participation of the variable.
Fixed indexed annuities are the combination of these two types. The insurance companies allow you to purchase a product that acts very much like a traditional fixed annuity. They typically provide a fixed minimum interest rate, and then allow the contract to grow in relation to the market index that it is associated with. In market downturns, the annuity continues to grow or remain at the pre-established minimum interest rate, and never risks your hard-earned capital. When the market rebounds, you immediately benefit from the market upturn and make a portion of the increase of the index.
All of this can seem a little bit too good to be true. For the most part, however, this is exactly how it works. Don't assume that the insurance companies are altogether altruistic however; they still need to make money for this to succeed.
To ensure that these indexed fixed annuities do not lose principal in downturns, the insurance companies must restrict part of the upward growth in the up years. Although your account will grow when the index grows, you will not get the full portion of the growth. Most find that this a fair trade for keeping your principal safe in volatile years.
The two most common types of crediting options for your account are a cap and a participation rate. The cap is simply a ceiling that the insurance company places on the interest rate in growth years. If you had a cap of 6% and the market index grew to 12%, your account would only receive the 6% growth. The cap allows the insurance company the ability to make up their loss in the market down years.
A participation rate is a percentage that the insurance company allows you to "participate" in the market upturns. If you have a participation rate of 50% and the market were to grow 14%, then you would participate in 7% of the growth.
There are any number of different combinations of these crediting options that you should be aware of on your fixed index annuity quote. Annual point to point, monthly averaging, annual reset, and any number of other ways the insurance companies calculate what you are able to receive from your account. Always make sure you understand how your fixed annuity works before you purchase it.
Although fixed index annuities can be based on any market index, the majority of the products on the market choose to be tied to the S&P 500. The annuity is reliant on any one stock, but on the market value of the entire index. This spreads a bit of the risk that variable annuities often face.
The primary advantage of a fixed index annuity is the fact that you are able to participate in market upswings all the while avoiding loss during market downswings. This is an excellent way to grow your account when times are good, and avoid losing your capital when times are not. Fixed index annuities are an excellent way for investors to secure their retirement income and allow themselves a degree of market participation as well.