How To Pick The Right Indexed Annuity

When it comes to lifetime income there are many options to consider within a fixed indexed annuity (FIA). Preferences may vary from hoping for upside market performance, to a more conservative approach with a fixed rate of return. It is important to assess each option to make sure you are picking the right FIA to meet your long term needs. Which way you decide to go can drastically effect the amount of income you can receive moving forward.

One FIA providing lifetime income will credit interest based on market performance. The better the market does, the better your income payout is down the road. In fact, there a few of these indexed annuities that provide increasing income in market up years that will not lose income down years. Typically, these kinds of annuities usually payout based on performances of a market index, like a spread on the Barclays Bond Index or a capped version of a like index. Choosing how your funds are allocated will determine what your future income looks like. Therefore, how your funds are allocated will dictate how much of a cap, or upside, you will make in a given year. The downside is that if the market performs poorly over a given time period, your starting income may be lower than anticipated. To help put it into perspective, insurance companies can provide detailed illustrations to show income performance based on the last 10, 20, and 30 year look backs. What this means is they show a period of time in the past as an example of how your annuity income may pay out moving forward. If you choose this type of payout for your annuity income within retirement, it is highly recommended that you use a diverse option with respect to allocation percentages to help balance unforeseen market events; which in turn can protect your payouts in the future.

The argument when choosing the best market based performance income annuity is in how to determine market performance moving forward. Factors such as domestic and global federal stimulus packages have deviated the market from its norm. It is evident that what caused market fluctuations over the last few years is completely different than what we have seen in the past 10, 20, or 30 years. So from a certain perspective, what we see moving forward may work in opposition to what we have seen in the past; especially given the state of our global economy.

Another option when considering lifetime income is the fixed option with the income account value (IAV). The IAV is a feature on some indexed annuities that is separate from the cash value, strictly used for income calculation purposes. Therefore your cash value and your IAV value will be of different values (the IAV value will likely be higher as time goes on) throughout the lifetime of your annuity. The IAV receives a predetermined rate of return each and every year until you start the income, guaranteeing a payout regardless of market performance. The risk being that extra income may be left on the table in the event of a strong market performance. Today, this rate of return will usually average 6 – 8% annually with a predetermined payout dependent upon age. The older you are, the higher the payout. Because this is more of a conservative approach, the insurance company may allow provisions within the IAV to allow increased income in the future when poor health follows in retirement. The purpose is to provide the retiree with additional income for external costs associated with long term care or the need of nursing assistance. Once again, this type of FIA is generally for the more cautious retiree who wishes to leave nothing at chance with his/her lifetime income. With this strategy the retiree can purchase this annuity and know exactly what income they will qualify for up to 10 plus years in the future.

One of the main dilemmas on choosing the right IAV within your FIA is both the income and interest crediting options your contract will come with. I always use the analogy: what you don't make on the popcorn you make on the peanuts; meaning you may sacrifice a lower rate of return on your cash value in exchange for a higher lifetime income payout within the IAV. Typically higher lifetime income payouts within the IAV come with lower caps on the cash value which can restrict the amount of interest you can earn. Remember, pretty much all FIAs today give the option of partial withdrawals to lifetime income (within the surrender period) as a liquidity feature. This gives the retiree the flexibility to stop and start his/her lifetime income at their discretion and instead take a partial withdrawal. The partial withdrawals are contingent upon the cash value, not the IAV, so how much interest you earn on the cash value can be detrimental to how much you can withdrawal over retirement (assuming the lifetime income is not elected). Furthermore, the cash value is usually passed on to the beneficiary in the event of death, not the IAV. This is why it is important to find a professional that can show you a perfect balance between your earned interest on your cash value and your IAV payout.

When choosing the right FIA for your income needs it is crucial to determine what your risk level is. The more aggressive, optimistic approach generally follows the direction of the lifetime income that can increase over time and is solely dependent upon market fluctuations. Whereas the more conservative approach will tend to lean towards the fixed rate of return with the IAV while adding long term protection, providing a guaranteed payout regardless of market performance. Whichever way you go on your lifetime income, it's crucial to know the facts to make the right decisions for retirement income.  

How Lifetime Income Stemmed From Permanent Financial Changes

 Believe it or not, less than 20 years ago lifetime income did not exist; nor did the fixed indexed annuity (FIA). It wasn't until 1997 that the first FIA was launched, with lifetime income coming into the picture almost a decade later. Today these products are used for long term retirement planning, ensuring that your retirement income will not be dependent upon external market events. However, these products would have never come into the picture if it wasn't for the financial changes that started taking place in the late 1980's.

From the end of the Civil War to the late 1980's, pensions were the safety net that employees could rely on for their golden years. It was common for an employee to work for a firm for 20 plus years, get a gold watch, and enjoy a pension for life throughout retirement; a fair tradeoff to say the least. Then the inevitable happened. Through a combination of medical advancements and market turmoil from a deregulated financial system in the 1980's, retirees started living longer than expected and financial hardships started taking place for big business. The combination of these events caused the pension to vanish, giving birth to the deferred compensation plan. Now the obligation of retirement was placed on the employee, a burden that few ever saw coming. Because of the absence of these pensions, the insurance industry focused on the needs of the individual and brought forth a new hybrid product, the FIA.

The FIA gives all the flexibility that the traditional pension failed to provide. Now the employee can redirect a lump sum (401k, IRA, or non-qualified savings) of cash into a vehicle that will guarantee a lifetime income independent of market fluctuations, while still maintaining access to the cash value. The cash value in an FIA can earn interest through a variety of options while never losing value to market performance. This is a huge benefit compared to a pension. Pensions, in turn, were group annuities where employees would contribute gross monthly installments in exchange for an income stream after X amount of years. Once the income was activated there was no cash value and income usually stopped at death. Let's take a closer look at how the FIA can provide an income stream for life.

An FIA usually comes equipped with a lifetime income benefit rider (LIBR). Basically, an account known as an Income Account Value (IAV) grows within an LIBR at a set rate each and every year regardless of market performance. The IAV is a non-cash value used as a formula to calculate the income you will be eligible for in the future. This formula will tell you exactly what you can expect for an income stream up to 15 years down the road. For general purposes, the more you fund the FIA with the more guaranteed income you can have access to. For this reason alone, many investors are redirecting a portion of their nest egg into these products simply as a substitute to the pension.

Today, billions of dollars are being repositioned into FIAs each and every year for retirement income that is guaranteed for life. With the obligation falling now on the employee to prepare for retirement, a shift in annuity income planning moved from a group of participants (pensions) to the individual (FIAs). Change is inevitable in a growing and volatile market place, especially if you are in the 95% of working Americans that do not have a pension. This is why it is important to embrace these individual income planning tools. Understanding how these positive changes can help you achieve your retirement goals is monumental to your long term success. As always, I highly recommend that you explore these options with a trusted licensed professional to help understand how an FIA could be of benefit to you in your retirement years.