Fixed Index Annuities (FIA) – What, When, and Why?

By: Tom Morrow

Fixed Index Annuities were introduced to provide the same principal protection from market losses enjoyed by all fixed annuity owners. But, here is the kicker…FIAs also gave the annuity owner the potential for higher interest based on the market index used.

The FIA era began in 1995 when a 60 year old from Massachusetts made a $21,000 premium in a Keyport KeyIndex annuity that grew to $51,779. Not a bad start for FIAs, and did I say something about “Principal Protection.”

The beauty of an annuity is SAFETY. You are guaranteed not to lose your principal, or any interest credited to your account. Like a Fixed Annuity, FIAs also guaranteed a minimum rate of interest. Is it any wonder why, FIAs have grown from just over $100 million the first year to (are you ready)…$210 BILLION at the end of 2010. There was something more than SAFETY going on here!

An FIA follows the trends of a market index, like the S&P 500. Your money is not invested in the index, it just follows the index. Here is what’s going on – You RETAIN YOUR GAINS. I wont get into the details, but simply put, your account is credited with interest from the gains, and if there are no gains, then zero percent of interest is credited. Your account retains the previous gains, and waits for the next up tick of the index for more gains. It resets at the low point, and starts all over at that point. That’s HUGE!

Nobody lets the Bears out on annuities. The diversification pixie dust (Read Dave Vick’s book Bat-Socks & Vegas) that Wall Street has sprinkled over your mutual funds, and equity accounts has time and time again found itself not immune to Bear markets. Millions of baby boomers who are now reaching retirement age in record numbers have seen the market give and the market taketh away from their 401ks. When the bears come out of hibernation, they just eat the legs right off of your retirement savings. This is more than enough to keep anyone from sleeping at night. Bear markets just don’t go away overnight. They can and have lasted for years.

Insurance companies are great at taking risks away from consumers, and putting it on themselves. Everyone understands life insurance. The insurance company knows approximately how long you are going to live according to actuarial tables, and price life insurance products accordingly based on your age, and other criteria. The insurance company always comes out ahead because they pool these risks with millions of policies. Some people die early, and others outlive the projections.

I would have liked to have been at the life insurance company meeting when it was decided that they could also take the risks of Mr. and Mrs. Consumer living to long. That has to be one of the best brainstorming meetings of all times. Someone was really thinking outside the box, and the rest is history.

Last year, there were over 131,000 people in the United States that lived to be 100 or older. That figure is growing every year. Annuites, fixed or FIAs, can give a baby boomer an income for life, that they can’t outlive. With all of the concerns over Social Security, current inflation, and low interest rates, that is a benefit worth considering.

Speaking of low interest rates, find yourself a good savings calculator, and get a feel for the power of 2%. CDs are presently paying less than 1% interest. Fixed annuity products are paying 2 to 3 times these current CD rates, and FIAs have the potential of much more. The power of just a 2% difference compounded in a tax-derred account is eye opening at the least.

There is always a debate on how much of your retirement savings should be in annuities. Some financial planners like to use the Rule of 100. Simply take your age and subtract it from 100, and that is the amount of money you should keep in the market. The balance should be placed in principal protected products of which an annuity is one of the choices.

There are also test you can take to determine where you fall on the risks tolerance scale. Google Dave Vick, and purchase his book, Bat-Socks & Vegas. It is even available in a downloadable pdf format if you don’t want to wait and pay more for the hard copy. I promise, you will enjoy this book, and the risks tolerance test is included.

I hope this post has thrown some light on the What, When, and Why of Fixed Index Anuities. If you are a baby boomer, the time for taking market risks should be over.