Pros & Cons of Fixed Indexed Annuities

Annuities are investment offering tax-deferred growth on assets serving as supplemental retirement accounts. Fixed indexed annuities are hybrids of fixed and variable annuities, giving investors a minimum guaranteed return on assets with higher upside potential. The guarantee is given in years the market is down with higher returns reflecting the specific market the indexed annuity is mirroring when the index is up.

Principal Guarantee: Pro

Investors close to or in retirement often seek as little risk with assets as possible. The closer an investor is to needing the assets, the more he moves money into fixed or insured investments such as bonds, fixed annuities or bank certificates of deposit. When protecting assets earned over a lifetime is the primary concern of investors, the fixed indexed annuity provides that security. Investors may place the assets in the account and know that not only is the principal guaranteed, but a nominal interest rate will be paid to them regardless of what the market does.

Duration: Con

Most fixed indexed annuities are for a minimum of five years. This duration is required by insurance companies that need to ensure that they can remain solvent in difficult market periods. Coupled with the contract terms, fixed indexed annuities must be held until age 59 1/2 in order to prevent a 10 percent tax penalty taken on earnings distributions. For those who need more liquidity in retirement assets and savings, the fixed indexed annuity may not be a good option.

Market Participation: Pro

The fixed indexed annuity mirrors one of the major market indexes and when it goes up, investors won't have regrets about being on the stock market sidelines. When the index goes up, the fixed indexed annuity gets more than the minimum guaranteed return. This allows conservative investors the ability to grow assets without placing the principal at risk.

Limited Upside: Con

The market participation of fixed indexed annuity is limited. There are two factors to the limited upside: participation rate and cap on return. The participation rate is a percentage the investor receives on the index increase. For example, if the S&P 500 is up 10 percent but the participation rate of the index annuity is 80 percent, the investor gets 8 percent. The rate is defined by each indexed annuity contract and has a cap on return that limits the amount a person can earn in any one year. So if the S&P 500 is up 20 percent, but the annuity cap is 10 percent, the investor gets a maximum of 10 percent not the 16 percent suggested by the participation rate.