Index Annuity Guide


Welcome to the index annuity guide. The index annuity is one of the most versatile and timely investment options available today.

First, lets define an index annuity. The index annuity, also known as a fixed index annuity, or equity index annuity is a fixed annuity contract between a life insurance company and the policy owner which provides savings for retirement while providing the benefit of tax deferred growth. Also, the growth of the annuity is linked to an external equity or bond reference such as the Standard and Poors 500 Composite Index. However, the annuity is an insurance contract and the policyowner is not buying shares of any stock,  fund or index.

Now, let’s talk about one of the most important benefits of the index annuity. The ability of the contract owner to make stock market like returns when the stock market rises but never lose a penny when the stock market declines. Imagine going to Las Vegas and playing blackjack. Each time you won you got to keep your winnings but each time you lost, you got your money back.  For this benefit alone, almost every retirement plan should include an index annuity as a component of the overall plan.

Another important benefit  is the bonus. Some  insurance companies pay as much as 8-10% bonus on the initial amount invested. For example, a $10,000 initial premium with a 10% bonus immediately becomes $11,000.  If the account had 8% equity index gains the first year, the account would be worth $11,880 after the first year, a gain of 18.8%. Plus, the account value could never go below $11,880 unless withdrawals were made. That is why the index annuity is usually an excellent investment option for a risk averse investor.

Tax deferral is another important benefit of the index annuity. All earnings are tax deferred until withdrawn. Then only a portion of each payment is taxable because part of the payment is a return of premium. This could result in lower taxes if the owner is in a lower tax bracket during retirement. That may not always be the case, so proper tax planning is necessary when making withdrawals from an annuity or any tax advantaged investment such as an IRA or 401K.

Traditional savings plans such as CDs, money markets, mutual funds, and savings accounts are taxed every year.  By postponing taxes with the index annuity, the money will compound faster because interest is earned on the money that would have been paid in taxes.

Annuities are not life insurance, even though they are sold by life insurance agents and issued by life insurance companies. The Internal Revenue Service considers all annuities to be retirement plans so they are subject to the early withdrawal penalties if withdrawn before age 59 1/2.  An index annuity may be used to fund a qualified retirement plan even though they are not considered qualified for tax purposes.

Whereas life insurance is designed to create  an estate which is paid at the death of the owner, annuities are designed to liquidate an estate over a period of time by making payments to the annuitant for a specified time period or to the beneficiary in the event of the death of the annuitant.  This solves one of aging American’s greatest fears- running out of money.

The index annuity offers the potential for higher returns than the normal fixed annuity which pays a specified rate of interest each year. However, in years when the stock market is down the return on some index annuities is zero. This is much better than losing money which happens in most retirement accounts.

In summary, the index annuity can become a vital part of any retirement planning strategy because of its potential for high gains and no losses and attractive bonuses. In our next post in the index annuity guide, we will cover the working parts of the index annuity.