Layin’ It on the Line: What’s the difference between a fixed-indexed annuity and a variable annuity? | News, Sports, Jobs
“A variable annuity offers no guarantees on either principal or earnings and its premiums are invested and grow much differently than those of a fixed index annuity.” — Lyle Boss
Shopping for an annuity can be somewhat overwhelming, especially if you are trying to navigate the plethora of available annuity designs without an expert’s help. There are nearly infinite ways to structure this powerful wealth preservation tool, and there is no one “perfect” annuity product that will fit everyone’s needs and goals.
In my practice, I commonly encounter confusion when prospective clients try to understand the differences between variable annuities and fixed index annuities, or FIAs. It’s critical that anyone considering adding an annuity to their retirement portfolio know some of the key distinctions between these two products.
What are some essential differences between FIAs and variable annuities?
- Variables might have more growth potential, but they also carry greater risk. A variable annuity invests directly in the market. For this reason, it is possible to lose some, even all, of your investment money. When you place your cash into a variable annuity, you will have a predetermined selection of mutual funds from which to choose. These could include bond funds, stock funds, real estate funds or commodities, to name a few. Investment selections in a variable annuity go into what are known as “subaccounts.” These subaccounts are directly in the stock market. On the other hand, A FIA has no subaccounts and doesn’t correlate to any financial market. A FIA earns its interest based on its link to an underlying financial benchmark or index. Many fixed annuities use the well-known S&P 500 as their benchmark, although you will run across others. With a fixed index annuity, the issuer allocates premium dollars into its general fund, putting most of that money (around 90 cents of every dollar) into lower-risk, fixed-income assets. When your index goes up, the interest earned is a percentage of that uptick. Your initial investment and any interest already credited are guaranteed against losses if the index goes down.
- Regulatory bodies treat the two products differently. A variable annuity combines insurance and securities, while a FIA is strictly an insurance product. This is why anyone trying to sell you a variable annuity must be securities licensed.
- Fees and other costs are different for variables and FIAs. The typical variable annuity comes with a menu of expenses that can cost you, on average, from -3% to as high as -8%. In some instances, depending on the issuing company and your subaccount’s performance, you might see costs as high as -8%! WOW! Even worse, these fees are nearly impossible to detect in the prospectus the company gives you, unless you have assistance This smorgasbord of expenses includes mortality charges, administrative fees, fund management expenses, rider fees and other subaccount fees. In a fixed index annuity, the insurer adds all these costs into the initial contract design, sometimes along with growth limits on your potential earnings. Modern fixed annuities have low fees or even none at all. For instance, FIAs have no risk management fees because with fixed indexed products, there isn’t really any risk to manage. FIAs have The Legal Reserve Insurance Companies to guarantee safety and absorb any possible risk. You should know, however, that when you purchase a fixed annuity with an optional lifetime income rider or other add-ons, you may pay a rider fee, depending on the company and product. Typically, that fee is around 0.95% annually.
Take it from the Boss: Variable and fixed index annuities are both marketed as “safe money” products, yet they differ significantly. Variable annuities, while they may have slightly more growth potential, are loaded with costs that can eat up your gains. Variable annuities expose your money to greater risk and do not protect your profits or principal. If you are someone who can’t afford to lose a single cent in retirement but still want some part of the market upside, your best option is a fixed index annuity. Talk to a seasoned annuity expert today to help you achieve the full disclosure and transparency you need to select an annuity contract that best fits your unique needs and goals.
Lyle Boss is a member of Syndicated Columnists, a national organization committed to a fully transparent approach to money management. Boss Financial, 955 Chambers St., Suite 250, Ogden, UT 84403. Telephone: 801-475-9400.