June 19, 2024
With interest rates nearing their peak, fixed index annuities are worth a closer look.


With recent interest rate hikes, the Fed’s current target rate of 5.25% to 5.5% is now the highest in 22 years, making it an ideal time to take advantage of financial products that perform well in a higher interest rate environment. Are. While CDs and fixed annuities may immediately come to mind, there is an additional product worth considering right now – a fixed index annuity.

A fixed index annuity, available from life insurance companies, offers the possibility of higher interest rates than bank products and protects your principal from loss. You earn interest based on the performance of an index such as the S&P 500, subject to the carrier’s current participation rate and limits. Both the participation rate and the limit are affected by interest rate changes and are relatively higher now due to the Federal Reserve’s last 11 rate hikes.

Let’s look at how this could work for you as a potential owner of a fixed index annuity. If the stock market index you’re tracking increases 10% year-to-year and your fixed index annuity has an 80% participation rate, an increase of 8% would be your gain. The insurer may have a limit rather than a participation rate, so if the stock market returns a strong 30%, you are likely to have a significantly lower amount accumulated in your annuity than if the limit is 12%. If you view these limitations as dark clouds, here’s a silver lining: The upside performance curbs are balanced by protection from downside risk. And every year you can make a fresh start, which means if the market index falls 20% in a year, you don’t have to wait for the index to rise back 20% to start making money. Interest is credited to your account each year. That interest is locked in and becomes part of the guaranteed principal amount.

Then, when stock market performance is poor or negative, a fixed index annuity provides a guaranteed floor that protects earnings and principal.

Remember, an annuity is backed by the financial strength of the insurance carrier. There is no FDIC insurance, so it’s smart to buy a product from a financially strong insurer with high scores from major third-party rating agencies.

You are sacrificing a certain amount of liquidity over the term of a fixed indexed annuity just like you do with a CD. Many products allow withdrawals of up to 10% per year and impose surrender charges on percentages higher than that. Surrender charges are generally higher in the initial years and reduce as time passes. With most fixed index annuity products, the penalty for total withdrawals phases out after 7 to 10 years. Some people use the 10% free withdrawal provision to build retirement income while leaving what they have in the market.

When people hear the term “annuity,” their first question is often related to the cost of the product. While variable annuities have a reputation for being expensive, many fixed index annuities are zero-fee. The insurance company makes money on the difference between what you pay and what you earn. This can be a reasonably priced way to pursue growth and protect principal. You’ll have to pay more if you choose to add riders, such as one that guarantees minimum withdrawals even if the annuity value drops to zero.

If you’re one of the many people who has focused on the negative impact of high interest rates after purchasing a car or home equity loan, now is the time to focus on the positive side. Fed action has given you an opportunity to earn healthy returns with minimal or no risk. If you’re a conservative investor who is retired or nearing retirement, view this environment as a gift… that won’t be available forever. If you think a fixed indexed annuity may be right for you, act quickly but prudently, preferably with the advice of an experienced financial professional.

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