In this series, Annuity Alliance will provide some answers to some commonly asked questions about fixed indexed annuities. These excerpts are provided from the Indexed Annuity Leadership Council (IALC).

What is a fixed indexed annuity? How does it work?

A fixed indexed annuity, or FIA, is a retirement product that provides you guaranteed income during your retirement. FIAs are sold by insurance companies. When you purchase an FIA, either in a single lump sum or in multiple payments over time, the insurance company invests that money and credits interest to your annuity. Unlike a 401(k), however, the insurance company absorbs the risk of market downturns, guaranteeing that you will receive – at minimum – the principal amount you paid at purchase. In other words, the value of your money will never decline due to market loss for as long as it is in the FIA; but it does have the opportunity to increase, depending on the performance of the index it is linked to.

What is the difference between FIAs and variable annuities?

FIAs guarantee a minimum fixed rate of return, regardless of market volatility, whereas the rate of return for variable annuities depends on the performance of the linked stock, bond, or money market investment. With FIAs, the insurance company assumes the risk, protecting the principal from market volatility for the annuity holder. With a variable annuity, this is not the case; the consumer assumes the risk.

I have a strong 401(k) or similar account. Why would I need an annuity?

A strong 401(k) is undoubtedly a key component of one’s retirement plan, but diversifying your portfolio to balance risk and growth is a wise move. FIAs are a smart way to minimize risk for retirees because you won’t lose money during a market downturn. As long as the contract funds are not withdrawn through the surrender period, the principal is guaranteed by the insurance provider.

What are the benefits and downsides of FIAs?

The key benefit of an FIA is that it offers growth potential with principal protection from market loss. Unless you surrender your contract early, you cannot lose money. Your principal is guaranteed even if the linked index drops. Another benefit is that, as with a 401(k), any growth is tax-deferred. It’s also worth noting that if withdrawn before retirement age or the full length of the contract, FIAs are subject to surrender charges. FIA returns are also often capped, meaning that there is a limit to how much the annuity holder can gain in a year, even when the index performs very well. But remember, even if the index goes down, the FIA doesn’t lose value.

Is lifetime income really guaranteed?

Yes, as long as you hold the annuity for the full term of the contract. Liquidating annuities before the contract ends will result in a surrender fee, which varies by provider. Before purchasing an annuity, speak to the insurance provider to find out the exact terms of these fees, and evaluate your comfort level with the terms of the contract.

Are FIAs safe to purchase?

FIAs are safe to purchase for anyone who is comfortable with the structure of the product. A risk to an FIA is if the insurance company becomes insolvent and cannot pay its claims, but in this highly unlikely scenario, state-run insurance guaranty associations could cover a portion of the annuity. Still, it is recommended that anyone interested in an FIA, or any insurance product, consider the financial strength rating and historical performance of the insurance company from which they intend to purchase.

If my FIA balance grows one year, can I lose those gains the next?

Once interest is credited to an annuity, it is locked, and is not subject to market volatility. The timeline for when gains are locked in depends on the crediting strategy. For most FIAs, gains are locked in at the end of each year. If, for example, an FIA purchased in the amount of $100,000 were to earn 3% in its first year, the insurance company would consider $103,000 to be the new “floor,” guaranteeing this amount through the following year. The same process occurs annually through the end of the FIA contract.

About the IALC

Established in 2011, the Indexed Annuity Leadership Council (IALC) is a consortium of life insurance companies that offer fixed indexed annuities (FIAs). The IALC’s mission is to help educate the public, including retirement savers, the media, regulators, and financial professionals about the benefits of FIAs. These products offer principal protection from market loss, a predictable, guaranteed retirement income, and can contribute balance to retirement savers’ long-term financial plans. You can visit their website at fiainsights.org.