How Index Annuities Work

How Index Annuities WorkIf you’ve been considering a fixed annuity for retirement, you may have come across index annuities. What are they, and do they have a place in your retirement income plan?

Read on to learn more.

What’s different about index annuities

Especially when markets are rising, one of the major concerns that potential annuity buyers have is that they’ll miss out on future market appreciation. After all, a fixed annuity involves paying out a lump sum, the annuity premium, in exchange for a “fixed” rate of return – otherwise known as the guaranteed monthly income paid out by the insurance company.


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This is a legitimate concern when markets are up.

But there is, of course, a downside to staying invested in the market – literally. If and when markets fall, retirees can experience stress or even financial strain.

Index annuities are designed to balance these concerns.

They provide an interest rate that fluctuates with an index, such as the S&P 500, so that if the index rises your income can, too. The difference is that your market exposure is limited: your interest won’t rise indefinitely, meaning it’s capped, and it also can’t fall below zero.

This gives annuitants the chance to participate in bull markets without risking the loss of principle that can accompany bear markets.

How you can use them

One situation that springs to mind is a classic one for many financial planners: a retiring couple wants to develop guaranteed income streams – except one person is also a devoted investor who doesn’t want to “cash out” of the market.

Jeanine and Randy fit this profile: Jeanine was very concerned about reducing risks to the couple’s retirement income so that they could focus on other priorities – like travel and hobbies. But Randy, watching the 2017 bull market, couldn’t shake the feeling that they’d be giving up on a good thing if they shifted a significant amount of savings into an annuity.

The couple was an impasse, but their Vitucci & Associates advisor recommended an alternative: an index annuity. This could provide the guaranteed income Jeanine wanted without giving up on the markets altogether.

After discussing whether and how a fixed annuity would fit into their overall financial plan and retirement goals, the couple asked their advisor to go for it – and while Randy sometimes ribs his wife for pulling them out of the market “at such a good time!” it’s all good natured, and they both transitioned into retirement with the feeling that their respective needs were addressed.

In this situation, an index annuity also made sense for other financial and personal reasons. Be sure to speak with a qualified advisor before deciding whether this would be the case for you.

What about the risks?

Like every fixed annuity product, the guarantee of income for the chosen term is dependent on the financial stability and creditworthiness of the insurer. It’s very important to conduct appropriate due diligence on possible fixed annuity contracts to minimize this risk.

You also won’t get to fully participate in market growth, as index annuities tend to cap potential income gains at a certain amount (you can generally choose between varying levels of participation). This is essentially the cost of complete downside protection.

Price is another factor: we suggest working with a knowledgeable insurance broker to find a policy that can balance the benefits of an index annuity with cost effective pricing and a sterling reputation.

Don’t transition into retirement without a plan

Making decisions about income sources is a critical part of prudent financial planning. Don’t fly into retirement without addressing these issues: download our free Retirement Transition Guide and start working towards a personal retirement income plan that makes sense for your family today.


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Let Us Help!

We can discuss this topic and more at a complimentary appointment. As a bay area retirement planning coaches, we can give you a review and make suggestions based on your retirement objectives.

Important Disclosures

The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by United Planners.

To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk. Neither diversification nor asset allocation can ensure a profit or prevention of loss in times of declining values. United Planners does not render tax advice.

Securities and advisory services offered through United Planners Financial Services, member FINRA, SIPC. Pasquale Vitucci, CA Insurance Lic. # 0758212, is an Endorsed Agent of Vitucci & Associates Insurance Services CA Insurance Lic. # 0I06319. Vitucci & Associates Insurance Services and United Planners are separate and unrelated companies.
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Further Reading

Index annuity basics: