Fixed-Index Annuity Review: FIAs Outperform Bonds!?

Estimated reading time: 13 minutes

Looking for a way to grow your wealth while protecting your retirement savings? Our fixed-index annuity review breaks down why this annuity type is a game-changer. This financial tool can offer both growth and protection—without the risks of traditional investing.

Fixed-indexed annuities (FIAs) are powerful financial tools that protect your principal and have also been shown to outperform bonds. Recent research reveals that FIAs provide market-linked returns with built-in security, making them a compelling alternative for investors seeking both growth and protection.

In this article, you’ll learn how fixed-indexed annuities can provide market-driven growth without the volatility, why they often outperform traditional bonds, and how they can be a smart addition to your retirement strategy.

What are Fixed-Indexed Annuities (FIAs)?

Fixed-indexed annuities are insurance products that provide a unique blend of security and growth potential. They offer principal protection, ensuring that your initial investment remains safe while also linking returns to the performance of a specific market index, such as the S&P 500. This structure allows investors to participate in market gains without the risk of direct market losses.

For more information on annuities in general, read the article linked below.

How Do Fixed-Indexed Annuities Work?

An FIA is a long-term financial product designed to provide growth and income. Their performance is tied to an index, but they include mechanisms that cap both potential gains and losses. Unlike direct market investments, FIAs do not suffer losses when the market declines. In short, they pose less risk than other investments, such as index funds.

Accumulation Phase Explained

During the accumulation phase, the invested funds grow tax-deferred. The annuity’s value increases based on index performance, subject to the policy’s participation rate and cap rate. In long-term contracts, these can be a great financial planning tool for your retirement years as the potential return has the time (and protection from market risk) to grow.

Distribution Phase Explained

Once the annuity matures, investors can choose a lump sum, periodic withdrawals, or a lifetime income stream. This phase determines how the annuity’s earnings are distributed and is a key component of retirement income planning.

Some investors take advantage of an additional feature called an income rider, which can turn on a cash flow. This cash flow provides a guaranteed income stream, like a pension, that will last for the rest of your and/or your spouse’s life.

Key Features of FIAs

Understanding Participation Rates

A participation rate determines the percentage of index gains credited to the annuity. This means that while the annuity is tied to the performance of a market index, the credited return is only a portion of the total index gain. For example, if the market rises 10% and the participation rate is 80%, the annuity credits 8%. 

Participation rates can vary depending on the insurer and the specific annuity product, and they play a crucial role in determining the growth potential of an FIA. A higher participation rate can lead to stronger returns, making it an essential factor to consider when selecting an FIA.

Caps on Returns: What You Need to Know

Cap rates set an upper limit on returns. For example, if a cap is 7% and the index grows 10%, the annuity earns 7%. 

Most FIAs use either a cap or participation rate to share the overall growth potential of an FIA. Understanding caps and participation rates is crucial, as they determine how much of the market’s gains investors can actually capture while still maintaining the downside protection that FIAs offer.

Minimum Returns and Safety Nets

FIAs guarantee that even in market downturns, returns will not fall below 0%, ensuring that the principal is always protected.

For example, consider the year 2008, when the S&P 500 plummeted by nearly 38%. Investors holding traditional stocks and even some bonds faced massive losses. However, an FIA with a 0% minimum return guarantee would have preserved the principal investment, ensuring that the investor did not lose any money. While they wouldn’t have gained during that downturn, they also wouldn’t have suffered the devastating losses that the market experienced. This safety net makes FIAs particularly appealing for those looking to protect their retirement funds from extreme volatility.

Benefits of Investing in FIAs

Growth Potential Considerations

Unlike bonds, which provide fixed interest, FIAs allow participation in market upswings while safeguarding principal. 

For example, in 2016, the S&P 500 returned approximately 9.54%, while the Bloomberg Barclays U.S. Aggregate Bond Index returned about 2.65%. If an FIA had an 80% participation rate with a 7% cap, an investor would have received a return of 7%—significantly higher than the bond market while still protecting the principal in case of a downturn. This ability to capture market gains while avoiding losses makes FIAs an appealing alternative to traditional bonds.

Tax Deferral Advantages

Earnings in annuity contracts grow tax-deferred until withdrawal, allowing the investment to compound over time without the drag of annual taxation. This tax advantage can significantly boost overall returns compared to taxable bond interest, which is subject to regular income tax. For investors in higher tax brackets, the ability to defer taxes until retirement—when their tax rate may be lower—can lead to substantial long-term savings and more efficient wealth accumulation.

Example: Consider a married couple in their mid-50s with a household income of $80,000. They invest $100,000 in an FIA with a 7% cap. Over the next year, the S&P 500 gains 10%. Due to the FIA’s cap, their credited return is 7%, adding $7,000 to their investment. Meanwhile, if they had invested in taxable bonds yielding 3%, they would have earned $3,000, but after accounting for a 22% tax rate, their net gain would only be $2,340. By choosing an FIA, they not only earned a higher return but also deferred taxes until retirement, allowing for greater compounding over time.

Variable Returns: Opportunities and Challenges

While FIAs offer higher return potential than bonds, the returns are not guaranteed and fluctuate based on market performance. However, unlike traditional bonds, FIAs provide a crucial safety net—your principal is protected even in market downturns. This means that while you may experience lower returns in some years due to index fluctuations and caps, you won’t suffer devastating losses like those seen in bear markets. Additionally, FIAs often outperform bonds over the long term, particularly in low-interest-rate environments, making them a powerful tool for conservative investors looking to balance security with growth potential.

Drawbacks of Fixed-Indexed Annuities

Surrender Charges Explained

Most FIAs have surrender periods ranging from 5 to 12 years, during which early withdrawals can result in penalties. These charges are designed to compensate the insurer for the upfront costs associated with issuing the annuity, such as commissions and administrative expenses. The surrender fees typically decrease over time, often starting at 10% and gradually declining to 0% by the end of the surrender period. While this may seem restrictive, it’s important to note that many FIAs allow for penalty-free withdrawals of up to 10% of the account value annually, providing some liquidity for unexpected financial needs.

Insurance Company Stability Risks

An annuity is only as strong as the insurer backing it. Choosing a highly rated insurer is critical because the financial strength of the issuing company determines its ability to honor long-term commitments. Insurers with strong credit ratings from agencies like A.M. Best, Moody’s, and Standard & Poor’s are more likely to fulfill their payout obligations, even in times of economic uncertainty. Before investing in an FIA, it’s important to research the insurer’s financial stability and past performance to ensure your retirement savings remain secure.

At Abrams Insurance Solutions, we recommend only using insurers with an A rating. 

Fees and Other Costs to Consider

Some FIAs have fees for additional riders, such as income guarantees or enhanced death benefits, which can affect returns. These riders, while offering valuable benefits like lifetime income or increased death benefits for beneficiaries, come at an extra cost that can reduce the overall return on the annuity. Fees for riders vary depending on the insurer and the specific features included, typically ranging from 0.5% to 1.5% of the contract value per year. It’s essential for investors to carefully weigh the advantages of these riders against their costs to ensure they align with their financial goals and retirement planning needs.

Common Myths About FIAs

There are many misconceptions about FIAs, leading some investors to overlook their benefits. Here are five common myths debunked:

Myth #1: FIAs are overly complex.

Fact: While FIAs have several components, such as participation rates and caps, they are structured to be straightforward investment tools. A financial advisor can help you understand their workings and benefits tailored to your needs.

Myth #2: FIAs lack liquidity.

Fact: While FIAs have surrender periods, many allow for penalty-free withdrawals of up to 10% annually, offering flexibility for unexpected financial needs.

Myth #3: FIAs have excessive fees.

Fact: Unlike variable annuities, which often come with high management fees, FIAs generally have low or no annual fees unless additional riders are added. Any costs should be weighed against the benefits they provide.

Myth #4: FIAs don’t provide good returns.

Fact: FIAs participate in market gains with downside protection, meaning you can achieve reasonable growth without the risk of losing your principal.

Myth #5: FIAs are only for retirees.

Fact: While FIAs are popular among retirees, they can also serve younger investors looking for tax-deferred growth and principal protection.

Key Considerations for Retirement Strategy

Role of FIAs in a Diversified Portfolio

FIAs can complement traditional stocks and bonds, providing stability and growth potential. By integrating FIAs into a diversified portfolio, investors can benefit from the steady, predictable returns of bonds while also gaining exposure to market-linked growth opportunities. 

For example, an investor with a 60/40 stock-to-bond allocation might shift a portion of their bond holdings into an FIA, capturing upside potential without increasing overall portfolio risk. This strategy can help cushion against market volatility while ensuring consistent growth, making FIAs a valuable addition to a well-rounded financial plan. 

Additionally, because FIAs have the potential to earn returns that outpace inflation, they serve as an effective hedge against rising costs over time. Unlike traditional bonds, which may struggle to keep up with inflationary pressures, FIAs can provide growth opportunities that help maintain purchasing power in retirement.

FIAs Compared to Other Annuity Types

Fixed Annuities vs. Fixed-Indexed Annuities

Fixed annuities offer guaranteed interest rates, making them a predictable but often lower-yield option. In contrast, FIAs provide market-linked returns with downside protection, allowing investors to benefit from stock market gains without the risk of losing their principal. This means that while FIAs do not offer a guaranteed rate of return like fixed annuities, they present an opportunity for higher growth over time while still maintaining a level of security. This balance makes them a compelling choice for those seeking both stability and potential for increased earnings.

Variable Annuities: How Do They Compare?

A variable annuity invests directly in mutual fund-like sub-accounts, meaning their returns fluctuate based on market performance, making them inherently riskier than FIAs. While this exposure allows for the potential of higher returns, it also means that investors are subject to full market volatility and potential losses. FIAs, on the other hand, provide a safety net by ensuring that principal remains protected even during downturns, making them a more stable option for risk-averse investors seeking growth without excessive exposure to market fluctuations.

Making an Informed Decision

Evaluating Personal Financial Goals

Investors should consider their risk tolerance, retirement timeline, and income needs before selecting an FIA. Assessing these factors helps determine whether an FIA aligns with their financial goals, providing stability while allowing for potential market-linked growth. For instance, a conservative investor nearing retirement may prioritize safety and guaranteed income, whereas a younger investor might focus on long-term accumulation with tax-deferred growth. Additionally, evaluating liquidity needs is crucial, as FIAs often include surrender charges for early withdrawals. Consulting with a financial professional can help tailor the right FIA strategy to individual circumstances and objectives.

When FIAs Are Suitable for Investors

FIAs work well for conservative investors seeking market exposure without full risk. Here’s why:

• Principal Protection: Unlike direct market investments, FIAs ensure that your principal remains safe even during downturns.
• Steady Growth: Participation in market gains allows investors to enjoy reasonable returns while avoiding extreme volatility.
• Tax-Deferred Benefits: Earnings grow tax-deferred, maximizing compounding potential over time.
• Retirement Income Planning: Many FIAs offer lifetime income options, providing a stable source of funds for retirees.
• Diversification: FIAs can serve as a balanced component of a well-rounded portfolio, reducing reliance on bonds alone.

Fixed-Index Annuity Review – One of Our Top Favorites

Truth be told, one of our favorite types of annuities is the fixed-indexed. It is hands down the best annuity in terms of balancing returns and protecting your investment from wild swings in market conditions.

Allianz ABC Annuity – A Standout Choice

When it comes to top-tier fixed-indexed annuities, the Allianz ABC Annuity stands out as an exceptional option. Allianz is renowned for its financial strength and innovative products, and the ABC Annuity is no exception. This annuity offers a powerful combination of growth potential, downside protection, and flexible income options, making it an ideal choice for conservative investors looking for stability and opportunity.

Key Benefits of the Allianz ABC Annuity:

• Market Participation with Protection – Enjoy potential gains linked to market performance while ensuring that your principal remains safe during downturns.
• Attractive Crediting Methods – Allianz provides competitive participation rates, caps, and spreads to help maximize your earnings.
• Tax-Deferred Growth – Your investment grows without immediate tax implications, allowing for greater compounding over time.
• Guaranteed Lifetime Income – Choose from various payout options to secure a steady retirement income you can count on.
• Strong Financial Backing – Allianz’s long-standing reputation and high credit ratings ensure confidence in your investment.

Whether you are looking for a reliable way to grow your wealth or a dependable income stream in retirement, the Allianz ABC Annuity delivers on all fronts. With its blend of security and growth potential, it remains one of our top recommendations for those seeking a balanced and worry-free financial future.

Are FIAs Right for You?

Deciding on an FIA depends on individual financial objectives. Consulting a financial advisor can help determine if an FIA aligns with your long-term strategy.

How Abrams Insurance Solutions Can Help

At Abrams Insurance Solutions, we understand that navigating the myriad of investment options can be overwhelming. Our team of experienced professionals is dedicated to helping you make informed decisions tailored to your unique financial goals. We offer personalized consultations to assess your needs and provide guidance on whether a fixed-indexed annuity aligns with your retirement strategy.

Call us at (858) 703-6178 or click here to get instant fixed-indexed annuity quotes and see how they can fit into your retirement strategy.