Fixed indexed annuities in plain English: caps, participation rates and the 0% floor
You get part of the market's gains and none of its losses. Here's exactly how much of the gains, and what you give up for it.
A fixed indexed annuity (FIA) is a contract with an insurance company. Your money isn't invested in the stock market. Instead, the interest you're credited is linked to how a market index, such as the S&P 500, performs over a set period, usually one year.
The floor: why you don't lose money when the market falls
If the index is down at the end of the period, your credit is 0%. Your account keeps everything it has already earned. The ways your value can go down are different: taking out more than the free amount during the surrender period, optional rider fees, and on some contracts a market value adjustment if you leave early.
The upside: three ways your share of the gain is limited
The rates below are examples to show the math, not current rates.
| Method | How it works | Index up 12% | Index down 15% |
|---|---|---|---|
| Cap (e.g. 9%) | You get the gain up to the cap | 9% | 0% |
| Participation rate (e.g. 50%) | You get that share of the gain | 6% | 0% |
| Spread (e.g. 3%) | The gain minus a set percentage | 9% | 0% |
Most indexes used in FIAs track prices only, not dividends, so even an uncapped strategy won't match the full return of owning the stocks.
Caps can change, within limits
The insurer can raise or lower caps and participation rates, usually once a year on your contract anniversary. Every contract states a minimum they can never go below. Ask for the history of renewal rates on the product you're considering, not just today's rate.
Surrender charges and free withdrawals
FIAs are built for money you'll leave alone. Most have a surrender period of 5 to 10 years with a charge that shrinks each year. During that time you can usually take out about 10% a year with no charge. After the surrender period ends, the money is fully available.
As with any retirement account, withdrawals of earnings before 59½ may also face a 10% IRS penalty.
Fees
An FIA without optional riders usually has no yearly fee; the insurer earns its margin through the caps it sets. Optional riders, such as a lifetime income rider, cost extra, often about 1% a year. They're listed in the contract.
Who an FIA fits
- Fits: money you want protected from losses, with more growth potential than a fixed rate, that you won't need for the surrender period. And people who want a guaranteed lifetime income later.
- Doesn't fit: emergency money, money you'll need soon, or money you want fully invested in the market.
Think of an FIA as sitting between a CD and a stock fund: less upside than stocks, no losses from market drops, and more growth potential than a fixed rate in good years.
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