Annuities provide contract holders with an income stream later in their life, in exchange for them paying regular premiums now. Indexed annuities are a specific type of annuity, one that pays an interest rate based on the performance of a specified market index. Indexed annuities can be an effective investment vehicle in many cases, so here’s what you need to know before including one in your retirement strategy.
Indexed annuities are designed to offer owners the option to earn higher yields with minimized risk. They are most profitable when financial markets are performing well. The rates on an indexed annuity are calculated on the year-over-year gain in the index or its average monthly gain in a given 12-month period.
Annuities can appreciate over time, but you will never see the full benefits of a rise in the indexes that your annuity is invested in. Indexed annuities typically limit the potential gains at a certain percentage, called the participation rate, meaning the account won’t be credited with the full gains in some cases. Participation rates may be 100%, meaning you get credited with all of the gains, but some annuities have gains set as low as 25%. Though, it is more likely that gains will sit around 80 or 90% in most cases.
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There are some fees associated with owning an indexed annuity. In most cases, this will be assigned as a percentage fee that is subtracted from the gain in the index that your annuity is linked to. For example, if an index gains 10% and the fee is 3%, the annuity would be credited with an 8% gain. It is important to include this cost in your calculations when planning your retirement strategy.
There are some limitations that put an upper limit on the amount of returns you can receive on your annuity in a given period. For example, if the index your annuity is linked to has a 10% return, but your plan has a 3% cap, your account will only receive a maximum of 3%. This is the case for most annuities, so if you want a different product you will need to shop around.
Riders are extra features that can be added to financial products. A popular rider that is added to indexed annuities is the minimum lifetime guaranteed income rider. In exchange for additional payments, you can receive payments for life, regardless of your annuity account status. To learn more about annuity riders, you will need to speak with a financial advisor.
Who Needs Indexed Annuities?
To get the best idea of whether an indexed annuity is fitting for your situation, you will need to research all your options and stay educated and updated on all things involving annuities. This will help you determine if an indexed annuity fits into your retirement strategy.