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Does a Fixed Index Annuity get Market Returns?

I am licensed in all 50 states and I get a ton of calls from across the country full of questions, one being, “Are Fixed Indexed Annuities a good investment, and do they get stock market returns?”

The official name is Fixed Index Annuities (FIAs), but the product is also referred to by the public as Indexed Annuities and Equity Indexed Annuities. Some agents even over-hype the product by calling it a Hybrid Annuity. Side note, a hybrid is a plant, a car, and even a mattress. It is not an annuity.

So, the short answer to the initial question is that Fixed Index Annuities can be a good investment if you fully understand the benefits and limitations of the contract and if it fits properly within a portfolio. As for the stock market return question, that one is trickier. The short answer is that occasionally FIAs do get market type returns, but not the majority of the time.

For FIA critics, they would say that a broken clock is right two times a day when it comes to the market return question. It’s important to know the facts about this popular and controversial strategy before believing that too good to be true sales pitch because there is a good possibility that your advisor will try to sell you one.

CD Design with a Stock Market Pitch

So how does a Fixed Index Annuity work? Fixed Index Annuities were designed and introduced in 1995 to compete with CD (Certificate of Deposit) returns, and those are the return ranges that have been historically produced. In a non-qualified (non-IRA) account, FIAs grow tax-deferred, but they can also be used both IRA and Roth IRA accounts.

FIAs have a guaranteed minimum fixed interest rate that is a separate calculation from the call option accumulation value calculation.

A common call I receive daily is “What is the difference between a Fixed Annuity and a Fixed Indexed Annuity?” First of all, FIAs are Fixed Annuities but there is another Fixed Annuity type called a MYGA (Multi-Year Guaranteed Annuity). MYGAs are the annuity industry’s purest version of a CD, and the returns are solely interest-based. FIA returns are based on call options, so let’s dig a little further into how those work.

Calling All Options

OK, that’s a bad play on words...but Fixed Index Annuity returns are based on a call option on an index such as the S&P 500. That is the most popular market index used, but there are over 40 indices currently used with FIA product offerings.

It’s important to point out that the FIA index return does not include dividends. That’s a big deal when you consider that over 50% of the S&P 500 index (i.e. market index) returns have historically been the dividends. The FIA return is based on the performance of that chosen index without the dividend. So if the S&P 500 index return starts at 3,000 and ends a year later on the contract anniversary date at 3,500, that northern movement is where the FIA “stock market” type return is calculated. That is a very basic Fixed Index Annuity example called “point to point” or contract anniversary date to contract anniversary date the next year.

To validate the complexity of the product, there are currently over 700 index options to go with the previously mentioned 40+ index choices, some of which are made up out of thin air.

FIA index return gains (if any) are permanently locked in on the contract anniversary date, but they also have limitations called “caps” and “spreads. FIAs can be complicated and difficult to understand, so take your time and don’t be pressured into making a buying decision.

Lifetime Income Delivery System

In my opinion, Fixed Index Annuities are best used as an efficient delivery system for guaranteed income and lifetime income by attaching an Income Rider at the time of application.

Income Riders are contractually guaranteed future pension type payments that are a separate calculation from the accumulation (i.e. index call option) value. You retain full control over the asset by using FIAs with Income Rider guarantees, even when you are receiving lifetime income payments. This is important because many people want the lifetime income guarantee, but don’t want to “annuitize” and create an irrevocable contract.

Income Riders attached to Fixed Index Annuities gives you the income guarantee, principal protection, and the potential for better than CD type growth. Not too good to be true, but not a bad combination.

Not A Security

A typical question I get on a consistent basis is “Are fixed index annuities insured?” A FIA is a fixed annuity issued by a life insurance company and is backed by that carrier’s full claims paying ability and financial strength.

All annuities are contracts and all annuity contracts are different depending on the carrier and product type. It is not a security like a variable annuity.

Best Story = Top Seller

Indexed annuities are a great sales pitch story. “Market upside with no downside.” That sounds good on the surface but isn’t factual. Occasionally, you might get a good return on some random year but the blended long-term returns will be in line with CDs...or a little better.

FIAs should be valued first for their principal protection and then for their potential returns. You should also look at the surrender charges of the contract and, if possible, try to shorten that maturity. Also, you should consider what are the index participation rates and the renewal history of the issuing carrier.

The bottom line is that if the index performs, then you will most likely get a portion of that. In addition, that gain will be permanently locked in on the contract anniversary date. To me, those are good things but certainly not too good to be true.

Sales Pitch Dreams vs. Contractual Realities

If you decide to purchase a FIA, you need to “own if for the steak, not the sizzle.” In other words, you need to fully understand Fixed Index Annuity pros and cons, shop all carriers for the best Fixed Index Annuity rates. As well as find an agent or advisor who has access to a very good Fixed Index Annuity Calculator.

So, when you look for the best fixed index annuity rates, understand you are really shopping for an enhanced return CD strategy. That’s the rational approach to take.