What is an Indexed Annuity?
How Does an Indexed Annuity Work?
Anis a contract whereby an investor makes a lump-sum payment to an insurance company, bank or other financial institution that in return agrees to give the investor either a higher lump-sum payment in the future or a series of guaranteed payments.
Let's assume you'd like to invest in a vehicle that income. The insurance company in turn invests this $175,000 in order to generate your monthly payments. If the insurance company invests this money wisely, it can earn more on the money than it has to pay out to the owner of the and thus turn a .provide guaranteed monthly payments of $1,000 to you every month for as long as you live after you retire in five years. An may require you to deposit, say, $175,000 now to obtain this guaranteed future stream of
With an indexed, the insurance company invests the money and then agrees to pay the owner a set percentage of the increase in a particular , up to a maximum of a certain percent. For example, a Company XYZ indexed might pay the investor 85% of the annual increase in the S&P 500, guaranteeing a minimum of 3% per year and a maximum of 9%. So if the is up 10% in a year, the pay 85% of this, or 8.5%. But if the is up 25%, the pay only the maximum 9% that year.
An surrender period expires and the investor is at least 59 1/2 years old. The surrender period is the time (usually about seven years) during which the investor must keep all or a minimum portion of the money in the account or face surrender fees equal to a percentage (usually about 10%) of the withdrawal amount. The surrender period on is often seven to 10 years, which is longer than other annuities. Unlike IRAs, there are no restrictions on how much an investor can put into an .investor typically begins receiving payments after the
Why Does an Indexed Annuity Matter?
income and want to participate in the markets but with limited . They also have tax advantages: like 401(k)s and IRAs, for example, the interest, dividends and capital gains earned on an indexed 's underlying investments are tax-deferred until withdrawal (this means there is usually no additional benefit from holding annuities in IRAs or other tax-advantaged accounts). This provides two rewards: all of the 's and interest keeps working for the investor, and investors who use annuities for income in retirement are often in a lower during retirement than when working, which provides tax savings.can be very attractive for people who want guaranteed
However, wise investors must consider some important drawbacks to taxes on gains at their tax rate (rather than the lower long-term capital gains rate) when they make withdrawals. Further, when a beneficiary inherits an , he or she is taxed on the 's gains at the ordinary tax rate instead of getting a step-up in basis as would be the case if he or she had inherited .and annuities in general. For one, investors pay
Unlike bank deposits, the FDIC or other agencies do not insure annuities, and if the goes bankrupt, an can lose some or all of its value. Therefore, it is important to consider the creditworthiness of an issuer when shopping for an . Best's Rating Service, Moody's and Standard & Poor's all provide this service.
Fees are also a major source of controversy for annuities. There are often front-end loads, state taxes, annual fees based on a percentage of the account value, penalties, etc., and they may offset much or all of an 's tax advantages. Pressuring sales tactics and less-than-transparent disclosure have also tarnished the image of annuities, so wise investors should be sure to read these disclosure materials and ask his or her financial consultant plenty of questions.
Ultimately, the appropriateness of an indexed dependent on the investor's financial goals, tax situation and the types of annuities available. Inflation and interest rate expectations may affect the type of an investor chooses, as the investor's wishes for his or her dependents and heirs.is
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