Fixed index annuities help balance growth and capital preservation in your portfolio. You receive a fixed interest payment from the annuity but also limit your upside and downside potential. You could consider investing in a fixed index annuity when you're close to retirement.
Your retirement may be decades away or a matter of months. But at some point you’ll have to cross the retirement red zone—that final seven to 10 years before you stop working.
This period can be a bit tricky for some investors. You may still need to grow your portfolio, which entails taking market risks, and at the same time preserve capital, which entails reducing your market risk. It’s a dilemma—taking and avoiding risk at the same time. And while some investors may think “growth” and “capital preservation” are contradictions, combining them is possible if you know where to look. Consider a fixed index annuity.
Enjoying the benefits of market gains while keeping your losses low might be difficult if not impossible with traditional assets such as stocks and bonds. But a fixed index annuity—essentially a type of insurance product—might help you pursue both, assuming you can accept limiting your upside in exchange for downside portfolio protection.
An annuity is a contract between an investor and an insurance company that’s designed to provide a steady income stream. You buy an annuity, either paying all at once or over time. After a predetermined waiting period (which can be long or short, depending on the annuity), you begin receiving regular income.
A fixed index annuity is a different kind of beast—a hybrid of a couple types of annuities. Similar to a traditional “fixed deferred” annuity, it’s designed to provide regular interest payments. But instead of being fixed, the interest earned is tied to an index or indices—kind of like a variable annuity. Because it’s linked to an index, you may participate in some of the underlying indices’ positive returns, but—unlike most variable annuities—you’re also protected during negative years.
Most fixed index annuities have both a “performance cap” on positive returns (a ceiling on your upside) and a “floor” to protect you from negative returns.
Say you bought an indexed annuity with an upside cap of 5%. Here’s what you could expect:
Annuities have earned the reputation of being highly complex and unnecessarily complicated instruments. But not all annuities have convoluted terms and conditions.
Indexed annuities can be straightforward and less complex.
“Locked-in rates” are indeed locked in upon purchase. The interest rate on a fixed index annuity may vary annually depending on the performance of the underlying indices. But once you purchase an annuity with a locked-in rate, say, at 5%, that’s what you should get.
Also, performance caps and floors should deliver at face value. If your performance cap is set to 4%, then you may receive an annual payment of 4% as long as the market returns 4% or more. If the market returns a negative figure, you take no loss. No other variables should get in the way of this basic agreement between customer and provider. Please note, however, that all guarantees are based on the claims-paying ability of the insurer.
As you approach retirement, you may be looking to reduce your equities exposure to reduce your risk of loss. At the same time, you may also want to continue seeking growth to increase the value of your investments and future cash flow.
Rebalancing your stock and bond allocations might help you pursue this sweet spot in your portfolio. But remember that a fixed index annuity is designed to pursue this balance of security and relative growth. It may be worth considering as a potential addition to your portfolio.
Investors should carefully consider a variable annuity’s risks, charges, limitations, and expenses, as well as the risks, charges, expenses, and investment objectives of the underlying investment options. This and other important information is provided in the product and underlying fund prospectuses. Please read them carefully before investing.
Karl Montevirgen is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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