Few financial products generate as many strong opinions as annuities.
Ask ten people about them and you may hear everything from “everyone needs one” to “never buy an annuity.”
Neither extreme is particularly helpful.
Annuities are financial tools. Like any tool, they can be useful when matched with the right objective and inappropriate when they aren’t.
Let’s clear up some common misconceptions about fixed indexed annuities.
Myth #1: “Your Money Is Invested in the Stock Market”
Generally, no.
With a fixed indexed annuity, you’re purchasing an insurance contract. Your interest-crediting strategy may be linked to the performance of an index, but you don’t directly own the stocks that make up that index.
That’s an important distinction.
Myth #2: “You Get All the Market’s Upside With None of the Downside”
This statement oversimplifies how indexed annuities work.
Indexed annuities can provide protection against direct losses caused by a declining index, according to the contract’s terms.
However, the amount of interest you receive when the index increases can be limited by cap rates, participation rates, spreads, or other crediting provisions.
There is a tradeoff.
You’re giving up some potential market upside in exchange for contractual protection from direct index losses.
Myth #3: “Annuities Have No Risk”
Every financial product has some type of risk or tradeoff.
Indexed annuities may help reduce market risk, but owners still need to consider:
- Inflation risk
- Liquidity
- Surrender charges
- Insurer financial strength
- Opportunity cost
- Rider expenses
- Tax considerations
Annuity guarantees depend on the financial strength and claims-paying ability of the issuing insurance company.
Myth #4: “Your Money Is Completely Locked Up”
Most modern annuities provide some access to your money, although the amount varies.
Many contracts permit a certain amount to be withdrawn each year without a surrender charge. Some also have provisions for certain health or life events.
But an annuity is generally designed as a long-term financial product.
If you anticipate needing most of the money next year, an annuity with a lengthy surrender period probably isn’t the appropriate place for those funds.
Myth #5: “All Annuities Are the Same”
This is one of the biggest misconceptions.
There are multiple types of annuities, including:
- Fixed annuities
- Fixed indexed annuities
- Variable annuities
- Immediate annuities
- Deferred annuities
Even two indexed annuities can have dramatically different crediting strategies, surrender schedules, income features, riders, and costs.
Myth #6: “Annuities Are Only About Investment Returns”
For many retirees, the primary reason to consider an annuity isn’t maximizing return.
It’s creating predictable retirement income.
Certain annuity structures can provide income that continues for life, subject to the contract’s provisions.
That can help address another major retirement risk: longevity risk, or the possibility of outliving your retirement assets.
The Bottom Line
Indexed annuities aren’t appropriate for everyone, and they shouldn’t automatically replace stocks, bonds, cash, or other retirement assets.
But dismissing an entire category of financial products because of something heard online isn’t a retirement strategy either.
The better approach is to understand how an indexed annuity works, what guarantees it provides, what limitations it has, and whether those features solve a problem within your retirement plan.
