Last Modified on October 19, 2019

Index annuities are increasingly becoming a part of people’s financial portfolios. Its popularity has risen in the last few decades, as it protects investors from the direct risks of stock markets and provides a fixed annuity. But what exactly is this financial instrument and how does it work? And, is it right for all investors? Let’s find out.

What are index annuities?

Index annuities are fixed annuities that protect from downside market instability. They are also known as fixed indexed annuities or equity indexed annuities. They have features that align with both, fixed and variable annuities, and they offer a fixed, minimum guaranteed interest rate as well as returns linked to the market index.

In short, they provide: 

Fixed Annuity + An opportunity to earn from various stock market indices

A large number of indexed annuities are based on S&P 500 – a stock market index that tracks the stocks of 500 large companies in the US. Some offer different index options, too.

Now, let’s understand the lifecycle of index annuities that can be divided into four steps:

1. Index annuities are purchased by paying a lump sum amount. The amount is taken from 401(K) or other retirement savings accounts. The insurance company then invests this amount.
2. Next is the accumulation phase, during which, the annuities earn a fixed rate of interest and may earn interest from other indexes that are part of the fixed annuity.
3. Investors can then defer tax with fixed annuities, which means the money keeps compounding and growing.
4. The last is the distribution phase. The returns earned are either distributed at the end of the contractual period or are distributed throughout the investor’s lifetime.

Are index annuities a good investment?

Now that you know what index annuities are, let’s look at whether they are right for your investment plan and what are the factors that you must consider.

Compared to other investment instruments, indexed annuities could seem more complex, especially the calculation of the gains. Different firms use different methods for calculating the interest rates. Hence, it is advisable that investors must understand the details before investing. It is also advisable to consult a financial advisor to understand the details of the instrument.

Index Annuities Pros

• • Some indexed annuities offer different index choices. Hence, investors can choose a combination of indices.
  • It offers protection to the principal invested amount from downside market risks.
  • It provides a guaranteed minimum return, which can help investors plan for their retirement savings.
  • The index growth is calculated from the day the policy is issued.
  • It offers numerous options such as annual sum, monthly sum, and other strategies to choose from.
  • Investors can mix and match the options such as fixed rate, annual sum, and monthly sum. 

Index Annuities Cons

• • Indexed annuities are not the best kind of investment instrument, but they can be pretty good when the expectations align with the fixed annuities mentioned.
  • Often, indexed annuities are sold to investors with a false hope of market-upside returns.
  • Indexed annuities are good only when one has an understanding of realistic return expectations from the investment. It helps in allocating index annuities correctly in one’s financial portfolio.

3 Things you should do if you are considering investing in index annuities.

1. Find the right financial advisor

 A good financial advisor would be able to guide you and share the most relevant information with you. You must find an experienced financial expert through a professional financial advisory company.

2.Know what returns you can expect from index annuities

Have a realistic expectation. You can do this only when you understand the details of the way in which index annuities work. Your financial advisor would be able to explain it to you in detail.

3. Read the contract carefully

This is true with any investment. Read the details in your index annuity contract carefully. This will help you understand what returns to expect from your investment.

Still confused about whether or not you must invest in index annuities? Or do you have queries about the different indexes to consider for your plan? Consult financial advisors for their efficient and experienced advice and guidance.