What is a Fixed Annuity?
Fixed annuities are investment products designed for risk-averse investors, often saving for retirement. Most fixed annuities act similar to interest-bearing bank accounts or CDs but are better for a couple reasons. 1-They offer a higher interest rate than banks 2-The interest earnings grow tax-deferred in the account so you don’t have to worry about a 1099 every year like with a savings account. This leads many to ask the question, Can I sell my fixed annuity?
Equity Indexed Annuities
Equity indexed annuities (sometimes called fixed indexed annuities or FIAs) are fixed annuities whose performance is tied to some index, usually an equity index like the S&P 500 index or the Nasdaq 100 index. It could also be pegged to a fixed interest account.
Indexed annuities offer principal protection and also a guaranteed rate of return, often 0-2%. Even though the upside performance may be linked to an equity index, they are fixed annuities so they have a ‘floor’ underneath them to protect from downside risk (may depend on whether a rider was utilized).
Indexed annuities move somewhat inversely to variable annuities. While variable annuities follow the ebbs and flows of the stock market (given their typical allocations to stock mutual funds), indexed annuities become more popular during volatile or down markets given their floor. Because this safety, FIAs are increasingly being purchased by Americans in, or near, retirement.
In 2015, fixed indexed annuities had their best year ever, totaling $54.5 billion up from $48.2 billion in 2014 as investors shied away from variable annuities. Also, banks have participated more strongly in the sales process.
Also, with the low interest rate environment, fixed income annuities have been increasingly popular because their returns are higher than Bank CDs and most bonds. If interest rates were higher, FIAs may not be as attractive compared to simply buying bonds (which would also be cheaper).
Indexed Annuities Pros
Guaranteed Rate of Return–
Tax advantaged-The earnings and interest in Annuities grows Tax-Deferred until withdrawal. Unfortunately, once the payments start, that income is taxed as ordinary income (not the lower capital gains rate).
Social Security– Annuity income doesn’t count against allowable income for social security benefits.
Indexed Annuity Cons
Indexed annuities seem to offer the best of both world’s- growth potential in the stock market with accompanying principal protection. Here are a few of the drawbacks:
- Above average fees- Surrender charges can be very steep, especially in the first years after the contract is inititated.
- No dividends-Investors in equity indexed annuities miss out on the dividends in the stock indexes. The return is not tied to the indexes ‘total return’. Historically, about half of the returns from the stock market come from dividend reinvestment.
- Underperformance-In a bull market in stocks, FIAs will underperform given the caps, participation rates and dividend exclusion. Studies have shown extreme underperformance by equity-indexed annuities against a direct investment in equities over time.
- Inflation– Fixed annuities generally don’t keep up with inflation, unless you add a COLA (cost of living adjustment) rider to the contract, which is usually extra.
- Unregulated by SEC Equity-indexed annuities are not regulated by the SEC, even though they deal with equity indexes- a worrying notion to some. This means they are subject to the claims Paying Ability of the Insure
- Changing Terms-Insurer may be able to change terms of the contract on an annual basis.
- Complexity- These contracts are very complex and difficult to understand. Even when you do, the insurer typically has the right to change the terms of the contract you signed up for (generally on an annual basis).
Can You Sell Equity Indexed Annuities?
You should be able to sell your equity indexed annuities payments to a third party. Many annuity owners don’t even realize they can sell annuity payments to a third party-they believe they are stuck in the annuity forever. This used to be the case, but there is a growing secondary market that has sprung up, given the number of unhappy annuity owners who want to sell their annuity payments for cash.
Many annuity owners have been realizing the annuity no longer fits their investment objectives. Others may have inherited them and simply would rather have the money in one lump sum to do with as they choose, instead of waiting for payments. Given this demand, more and more funding companies enter the market every year, and that competition has made the buyer’s offers much more competitive.