An indexed annuity is an insurance contract that provides investors with the potential to earn higher returns than traditional fixed-rate annuities. The returns are based on the performance of an underlying index such as the S&P 500 or a bond market index. While they can offer greater rewards than other types of annuities, there are important things you should be aware of before investing in one.
How They Work
Indexed annuities are designed to provide investors with returns that are linked to the performance of a specific stock index or bond market index, without taking on direct stock market risk. When you invest in an indexed annuity, your money goes into a separate account where it is invested in bonds and other fixed-income investments. Each year, your return will be based on how well these investments perform and how much money is credited to your account from this investment income. Depending on which type of annuity you invest in, you may also receive additional credits based on the performance of a particular stock index or bond market index during the course of the contract period.
One benefit that indexed annuities offer over other types of fixed rate annuities is the potential for higher returns over time due to their linked credit components. Additionally, since the funds are held in a separate account – not directly exposed to the stock market – they provide investors with protection from any losses incurred if markets were to suddenly drop sharply. This security helps reduce fluctuations in value and further protects against loss due to economic uncertainty or downturns in any particular sector, industry or markets in general.
When considering an indexed annuity, keep these things in mind:
- Understand what type of index your policy is tied to and research historical performance trends for that particular index, as this will give you insight into how it might perform going forward;
- Be aware that many policies have surrender fees associated with them so be sure you understand all terms related to early withdrawals before purchasing;
- Make sure you understand exactly what type of fee structure may apply and consider annual fees when assessing potential returns;
- As with all financial vehicles, be sure that you can afford the payments being made into your policy and ensure that contributions fit within your financial plan and budget;
- Lastly, make sure that canceled bonuses due to early withdrawal don’t apply as this could significantly reduce total return on investment over time.