Fixed Index Annuities | Are They Right For You?

In this weeks show we talk about Fixed Index Annuities and if they are a right fit for you.  There can be a lot of benefits but there can also be a lot of pitfalls.  Making sure you know exactly what you are purchasing is very important when looking at these products as an investment.

Fixed Index Annuities Transcription

Good morning Vero Beach. Welcome to the Financial Pulse radio show. My name is Danny Howes, CEO of East Coast Tax and Financial Planning and your humble host. We’re talking about fixed index annuities today. Last week, we talked about variable annuities and if you missed that show, go to and click on Financial Pulse. You can listen to last week’s show. There is a lot of bonus material. I even have a video there where I do a whiteboard on how variable annuities work and there are even great tips for you to take down. There are written stuff there for you to take down if you’re considering buying variable annuity or if you have one; there are materials there.

But today is about fixed index annuities. I’d like to pair these up. This is our annuity series that we are doing in the next couple of weeks. I’d like to have them back to back – variable annuities and fixed index annuities. There is usually a tug of war between these two products. There are either advisors who love variable annuities and hates fixed index annuities; or loves fixed index annuities and hates variable annuities. What I say is there’s a place for both. There are some bad fixed index annuities out there; there are also really bad variable annuities out there. At the end of the day if you’re empowered, if you have the education, and you know what you look for, you could really make smart decisions if this is something right for you.

The week before last we talked about the three-legged stool of retirement income. In that three-legged stool, first leg is obviously social security. That’s a foundation of retirement income and it is what more than two-thirds of retirees depend on to have the lifestyle that they desire. Second leg is pensions. Unfortunately with pensions they are kind of going the way of the dinosaurs. Unless you work in healthcare or a teacher or a government worker, there are only a very few companies that offer very good pensions like we did in the past. That leg in the stool is a little bit wobbly. The third leg is basically investment income, your nest egg; that is income that you make from your nest egg to kind of fill the gaps between the other two.

What we talked about a few weeks ago is the fact that if pension is gone or dramatically reduced and not as strong as it used to be, that will really make that stool wobbly. Maybe you only have a two-legged stool but then you only have social security and investment income because I’ve never gotten a pension because you are a business owner, a doctor; you have a private practice or whatever the case may be. That makes it even more difficult and the third real big danger to the retirement income stool is the fact that interest rates are so low right now. It is very difficult for retirees, savers, and even pre-retirees to go out and say “I want to die down the risk of my money, portfolio, and investments; I just want to basically put my money to work for. I want to rip my money and have a safe account that pays me decent interest and preserve my principal.” That doesn’t exist in the mainstream anymore especially money markets and CDs safe bonds.

So what do we do? That’s where annuities can play a role. That’s where you see a lot of private placements and different kinds of interesting investments that have come on to the scene because people are starving to get income and they want to do it the safe way. That is when people are taken advantage of because there is so much stuff out there. This is what it is all about. Fixed index annuities can be that answer if they’re chosen and selected the proper way for those retirees or pre-retires who want to have safety in principal but have some good, moderate growth to pay them more than 1, 2 or 3 percent.

The way that fixed index annuities are calculated from a performance standpoint is this. This is a very traditional way. There are a couple of different nuances about it but I want to explain to you the nuts and bolts on the most traditional. That is what they call an annual point-point strategy. You take out the investment money in a fixed index annuity and that date is your contract date when they issue your policy. One year from then is your anniversary date. The only two numbers that matter for how the interest is calculated in the crediting of your annuity is what the index number was on the day you took it out and the anniversary day one year later.

Let’s take the most common S&P index option. Let’s say that between the day and one year from now, there was a 10% gain. By only looking at those two dates – it doesn’t matter what happens in-between – within those two dates what is the index number today, let’s say you have a 10% gain. You’ll get a portion of that 10% gain. That’s how your money grows – linked to the index but not invested in the stock market. This will make it a little bit clearer. On the opposite side of the coin let’s say those two numbers actually ends up in a negative rate of return and loses 10%. In fixed index annuities, it’s fixed so you won’t lose money. You won’t lose any of your principal or previous earnings, but you will get a zero percent. You wouldn’t need money that year. But at least you safeguard yourself from losses. That’s what has attracted to so many retirees and concerned investors; the fact that they don’t lose money due to market fluctuation or downturns.

That’s a really great answer, but here are some of the caveats you have to remember about that. It’s not as simple as that. There are what call spreads and limitations on how much you can earn in a fixed index annuity because they are protecting you on a downside. They’re not going to give you all 10% if it was up 10% and protect you 100% on a down if it loses 10% because financially that just doesn’t work out. What they do is limit the upside and that’s where there can be places that the insurance companies can really stick it to the policy holders.

It is called caps. You can be capped at let’s say 5, 6, 7 percent or even as low as 2 percent. What the difference is really from insurance carrier to insurance carrier and different index options available inside the contract. That’s what affects the performance so while you have that safe environment that your money is in and you can’t lose, that’s very comforting; the negative drawback can be very disappointing returns. The stock market has been doing very well lately so if you have a really low cap and the maximum you can only make is two or three percent that can be disappointing.

You have to make sure that you’re choosing a carrier that has really good renewal rates and really good caps and multiple index options so you can make good decisions to make those higher, more moderate returns as opposed to being stuck making really literally almost what only these make. That’s one of the big caveats that you have to be careful of when it comes to performance on a fixed index annuity.

The other things that we need to be careful about are some of the bells and whistles that we are going to talk about in the second segment. They are income riders and death benefit riders and some of these things that cause money to attach that can be very good and beneficial but just like variable annuities they can have some caveats and negative drawbacks to them. So how do you choose the right fixed annuity for a good performance?

There are two different types of fixed index annuity purchases just like with variable annuities. One is I just want to grow my money in a safe place without risk of loss of principal but I want more money than more interest that I can earn maybe in CDs or bonds. Then there is another decision of maybe you need income. Maybe you need to fill gaps in your retirement income whether it’s pre-deceasing of a spouse where there is loss of social security because we only need to keep the higher of the two. We don’t get to keep both social securities when one passes away. Or maybe there’s survivorship pension that you lost, or there’s only a portion of the pension that’s there.

There are different reasons why you’d want income so there is that decision: income. There is estate planning where you are not insurable and can’t get life insurance. You want to enhance your estate or your money is in IRA, and you want to enhance that money; then there’s what we call death benefit rider which will actually enhance the value of the account upon death.

When we get back, we are going to talk about those riders because performance is one thing, and it’s great to make money in a safe environment. But then how do you fill some of the gaps that might happen in life and how do these fixed index annuities possibly fit in there and how do you choose those?

If you want more information, you want to just dive deeper in education just go to and click on Financial Pulse. We have so much stuff in there. We got videos, various tutorials that are very educational. We will be back in just a bit.


Welcome to the Financial Pulse radio show. I am Danny Howes, your host and CEO of East Coast Tax and Financial Planning. We are talking about fixed index annuity as part of a continuation of our annuity series here on the radio show. We have a lot of bonus material because we only have so much time on the radio show that we put some stuff on the website. If you go to and click on Financial Pulse, there are a whole myriad of education resources there for you to help you in this subject and annuities in general. I break down the different types of annuities and how they work so you can be more educated. If you already have an annuity what do you do with it. Is it the right thing for you? Should you continue it? If you’re basically just considering purchasing annuity, what are some of the things you need to look out for and arm yourselves with education so you have the right questions to ask and know what’s right for you. That is what this is all about.

I want to talk about riders in this segment because most people that I run across have purchased or looking to purchase annuity because they’re looking to fill a gap or solve for a what-if. A what-if in life is what if my eye? died before my spouse or vice versa and there is loss of income? There is always an inevitable loss of income when we lose a spouse because with social security which most people have access to, unless you’re a government worker or for nonprofit, most people are going to lose some social security income once they lose their spouse. Social security rules are you only have to keep the higher of the two if you both are collecting social security. So you have to be very careful about that. You want to make sure you plan for that. People want to solve for that income with some of their nest egg.

Another what if could be well, maybe I don’t need income so much but I know we can get life insurance because of insurability. With un-insurability, you can almost solve that problem with a death benefit rider on an annuity. Death benefit rider is basically a guaranteed growth of your principal or investment that is enhanced upon your death and leaves you more of a legacy. Very popular for people in saying I’m not ever going to touch my IRA’s except for what the government forces me to with regards to minimum contributions. I want to enhance it either for my spouse of for my children so you can get a death benefit rider on that to enhance their lives.

You can have long-term care insurance. Maybe at this point in the game it’s expensive to buy traditional long-term care insurance and you have enough resources to buy paid up insurance policy so maybe you want to get an income rider that has what they call a long term care doubler. A doubler is basically takes the guaranteed income that a fixed index annuity with an income rider gives you and it doubles the income the moment you need long term care whether it be a nursing care facility or a home health care and so forth. One of the big things you need to be careful with that is that there are a lot of caveats with that. Some will say we’re only going to double it if you’re in a nursing care facility, we won’t cover home health care. Some will cover home health care. So you just got to look at the rules. What are the qualifications? Most of it is if you can’t do 3 out of 6 daily living activities then that’s what triggers it and you know to know from your doctor just like with any other long term care policy.

Let’s talk about income riders because these are the most popular rider chosen and the most misunderstood by policyholders. I have people come into my office all the time and they say I’ve got a fixed index annuity. I took that years ago and there’s a guaranteed 7%. Really? For how long? They’d say for life, I get 7% for life! Much to their dismay, unfortunately a lot of times, I had to show them that it’s not necessarily correct. You remember the words 7% and it really stuck out, and it sounded so good, and that’s what you want. You don’t want to earn 1 or 2 percent. 7% sounded great. This happens with variable annuities all the time, too because income riders on fixed index annuities operate much in the same way. What happens is if you are to draw a line down a piece of paper. On the left hand side you have cash value at the top. On the right hand side of the line write down the words income account value. You got two account values. The income account value is a phantom value that they use to calculate a pension income if you want to think about it that way; lifetime income benefit. It’s not real money that’s growing; it’s just a calculation that’s growing over time. I’ll get to that in a minute. On the left hand side your cash value in a fixed index annuity is growing according to the performance of the index choices that you chose over the years.

So let’s talk about the right side: the income account value. Many times they’ll say oh this grows guaranteed every year 6, 7, 8, I’ve seen as high as 10% every single year no matter what. Market goes up or goes down, it’s stuck right there at that mark. So they’re really attracted at that rate of return. You have to remember that is an income account value. If we fast forward to 10 years, let’s say we earned 7.2%, the rule of 72 to make it simple. Let’s say I earned 7.2% for 10 years. We put a hundred thousand dollars in there. That income account value after 10 years is going to have doubled. It means it’s going to be $200,000. It’s a great number and everybody loves that security knowing that it’s growing and guaranteed.

However, something else is going on over the left hand side of the ledger. At the left hand side of the ledger is the cash value. That cash value is growing determinant upon how the index option of your choice performed. They could perform less than the 7 or 8 or the big number on the right hand side. They can maybe be 3, 4, 5, 6 percent; whatever the case may be or, you might be able to get fortunate and if you have the right contract you stay pretty close. But if you fast forward 10 years from now, and the left hand side which is your cash value side in which you can just take your money and go, it’s real money. The right hand side is basically income account value money. You can’t just take that and go. At the end of 10 years if that hundred thousand became two hundred thousand on the income account’s side of the ledger, it will take you on an average 20 years to get all that money back. Sometimes a little bit sooner, sometimes a little bit later. But to get that full one hundred thousand, you will have to take basically around 20 years to get that by turning on the lifetime income. The beauty of that is it’s going to pay you that guaranteed income based off that higher value regardless of whether your cash value runs out. That’s the security and that’s the pension aspect of it. That can solve the factors of there’s no pension or there’s a reduction in income later on if you need it. The left hand side however will mainly grow out of moderate rate of return less than what the right side did.

What it can cause is golden handcuffs. If you don’t know that going into it when you get to that point you will get financially disappointed because wow the left hand side is only 150,000 and the right hand side is 200,000, I don’t want to give up that two hundred thousand dollar benefit. Insurance companies love making you make that decision because they win either way. You can too so long as you go into the beginning of that knowing how it can all play out and as long as it’s acceptable to you when you get to that point. It’s all about begin with the end in mind. I talk about this all the time; reverse engineering. How do you choose the right annuity? Reverse engineering. How do you choose the right index strategy? Reverse engineering. How do you choose whether you should do an income rider? Reverse engineering. Why do I say that so much? Because you always have to begin with the end in mind first when you go into an investment and then you will have to be able to live with the worst case scenario of that investment. That’s how can you can make a strong, confident decision. You feel good about your decision all throughout the life of that investment. That’s what it is all about.

I hope you got a lot out today. I know it’s a complicated subject. I will try to make it even simpler on our website. If you go to, you can click on Financial Pulse and you can see videos on this and write-ups I’ve done. I’m trying to make these as simple as possible. It’s really just about empowering you with education. There is a lot of buzz out there, particularly with annuities. I know you want to make money. Everyone wants to make money. It’s just making those smart decisions. I just want to challenge you on that. Educate yourselves. Every single Thursday at 10:30am right here on 107.9FM and 1370 AM on your radio dial. Next week we’re going to talk about fixed annuities and income annuities, SPIAs. If you don’t know what that is tune in next week because it’s big stuff.