Fixed Index Annuities

One type of annuity is the fixed index annuity (FIA) with an income rider attached.4 They are sometimes called “income annuities.”Let’s say you put $500,000 into an FIA, and let’s say the company gives you a premium bonus6 of 8%. That means you’re starting off with $540,000. That is the actual account value. However, the bonus generally has a vesting period, which means that it isn’t available for you to withdraw until a certain period of time has elapsed. In addition, you often will receive the bonus only if you take withdrawals from the annuity under a prescribed withdrawal schedule. In many cases, surrendering the contract in full will mean forfeiting the bonus amount, depending on the terms of the annuity.  That same $540,000 is also going to be what is referred to as an “income base.” In essence, with this annuity, you have two annuity values to account for, simultaneously.

Simultaneously, as the actual accumulation account is growing, the $540,000 income base or income account may also increase as well, by a specific “roll up” amount. This percentage of growth varies from company to company and by product, but the idea is the same. If you had $540,000 to work with, for example, that income base rolls up at X% per year. So at the end of 10 years, in the income base account, your XXX is now $XXX. If, at that point, you want to turn on that income rider, you may do so.

What you receive in the way of income is based on your age. If you are 75, for example, your annuity might have a lifetime payout of 6.5%, or $69,047 per year. The income would come every year (or every month if you wish) for the rest of your life. To extrapolate that, let’s say you get $69,047 per year for 20 years. You could collect $1,380,940 when all is said and done, even though you only put in $500,000.

And what happens if you die sooner? Let’s say a tragic accident occurs and both you and your spouse are killed after having collected only three payments from your lifetime income. You would have collected a total of $207,141. Some annuities offer minimum guaranteed interest rates, which may be as low as 0%. Assuming your policy offered a minimum interest rate of 1.25% in this example, your actual account value (not your income account), at that time would have grown at only the 1.25% guaranteed rate and would be $634,642. So when you subtract what you have taken from the real account value, there’s $427,501 left for the heirs. Why is that important? Because in an immediate annuity, if you put the money in, and you got a payout for your life, but once you die it’s done, your heirs didn’t get any money. With the income rider, however, it works differently. You get a guaranteed income that you can’t outlive, and if you pass away, your heirs get the difference between the actual account value and the amount of income you took.

If you are looking for income you cannot outlive, an annuity with a guaranteed income rider may be a good solution for a portion of your assets. They are not for everyone and they are by no means a one-size-fits-all solution to every income planning problem. But they have some exciting features.

By using an annuity as an income source, you may be able to delay taking your Social Security until age 70, which will make that income as high as possible. You may also have an income that can address with inflation through the purchase of an inflation rider, and be larger than it would have been had you taken it at age 62, and you reduce your taxes.

I would be less than forthright if I told you that an annuity did not come with a few moving parts. It does. And no one should buy any annuity without understanding all the parts and how they work. If your financial advisor cannot answer every question you have to your complete satisfaction and so that you know the features and benefits of the annuity and understand them the way you understand that your right shoe is on your right foot, then you are working with the wrong advisor if you want to put one of these instruments to work for you. Annuities have fees and charges, particularly a surrender charge that will apply if you take money out prematurely, which could result in a loss of principal and/or any credited interest. Also, withdrawals from an annuity are subject to income taxes, and if taken before age 59-1/2, may be subject to an additional 10% federal tax penalty.

1 Income riders may be optional or part of the contract, and may come at an additional annual cost.

2 This example is shown for illustrative purposes only. It is not guaranteed and does not represent any specific product or company.

3 Bonus annuities may include higher surrender charges, longer surrender periods, lower caps, higher spreads, or other restrictions that are not included in similar annuities that don’t offer a bonus.

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