A fixed index annuity is a type of retirement investment product designed to offer the investor a chance to participate in a portion of annual stock market gains without also participating in any losses. When considering the past performance of the stock market, many investors have been attracted to FIAs because of the guarantees in these types of contracts, both before and after retirement.
Although account balances in FIAs are connected to the performance of a particular stock market index, the owner’s money is not actually invested in the index itself. Instead, it is held in a separate account by the annuity carrier. On the owner’s contract anniversary, if the selected market index is higher than on the previous anniversary, interest is credited to the account up to a predefined limit, or cap. Any earnings above the cap are forfeited to the insurance company. Conversely, if on the owner’s anniversary the market index is lower than before, no reduction is made to the annuity account balance.
Having the ability to participate in a portion of stock market gains with no risk of loss is an extremely attractive feature of FIAs, especially to those individuals who have suffered significant investment losses. An FIA allows investors to stay involved with the stock market and still benefit from positive performance, while also being shielded from drastic or unexpected downturns.
One of the most significant problems with FIAs is the surrender period -- the length of time the account owner must keep his funds with the annuity carrier to avoid additional fees and penalties for transfers or withdrawals. The number of years in a surrender period varies with each annuity company and each product, but most average between seven and 15 years. If the annuity owner closes his account or withdraws too much money during the surrender period, he is assessed additional penalty fees by the insurance company.
Surrender charges are much higher in the earlier years of the contract, and have been seen as high as 12 to 15 percent. The charges typically decrease on an annual basis until the end of the surrender period, at which time no additional fees or expenses would be charged to the account owner for withdrawals.
A complaint regarding FIAs is about the additional bonuses commonly offered to those investors with much higher initial deposit amounts. Annuity companies usually offer FIA products with impressive bonuses added to initial contributions that are above a certain threshold. Those account owners without savings above this level do not benefit from the bonus funds added to the account balances of larger investors.
Index Crediting Dates
Another common, yet much less threatening, problem with FIAs relates to the index crediting dates and the potential for no growth in the account. Because most FIAs only credit owner accounts with additional interest increases on the policy’s anniversary date, those owners who repeatedly have flat or lower index levels will see no increase in account value. Although this is not a severe issue, a repeated lack of account balance increases will actually result in lower purchasing power in future years, due to simple inflation. Additionally, because FIAs do not actually invest account owner money into the stock market, those years where impressive gains are made may not result in equal gains to the annuity because of the existence of rate caps.