People looking to retire in the next few years may find their financial futures clouded by the looming threat of rising inflation. As food, gas, and housing prices continue to soar, and interest rates continue to fall, more and more individuals are starting to worry whether their fixed income assets will be able to grow enough to cover their living expenses after retirement.
If you find yourself in this predicament, it might be time to investigate an alternative investment method in your financial future, such as a fixed or fixed index annuity. Keep reading to learn more about how a fixed index annuity can help offset future losses from inflation.
Rising Inflation in 2022
There’s no doubt that inflation is trending upward at an alarming rate. Consumer prices in the United States rose by an astonishing 9.1% in June, the most significant increase since 1981. This becomes all the more disturbing when you consider that inflation has seen its largest increase since 1981 every month in the past five months.
As inflation continues to rise over the year, interest rates will continue to fall, meaning some financial strategies like CDs and savings accounts won’t necessarily be able to generate enough interest to keep their owners earning a comfortable “wage” after retirement.
How Annuities Can Protect Your Money from Inflation
Fixed index annuities offer a middle ground between investing in stocks and choosing a more stable but less growth-oriented form of investment such as a bond. Investing in a fixed index annuity can remove market risk from returns while still providing annuity owners with a steady stream of retirement income. This is because fixed annuity contracts include a guarantee that the insurance company will pay you a fixed, predetermined amount each month no matter what’s going on with inflation.
Important Features of Fixed Index Annuities
Before deciding to protect your retirement income by purchasing a fixed index annuity, it’s important to make sure you understand the various features and terms associated with annuities.
The term “indexing method” refers to the approach used to determine how much the index has changed. The most common indexing methods are annual reset, high water mark, low water mark, and point-to-point.
The index term is the period during which the index-linked interest, if any, is calculated. Any interest an annuity accrues is usually credited after the term. Most terms run for six or seven years, but they can range anywhere from one to ten years in length.
Some annuity contracts offer single terms, and some designate separate consecutive terms. Most contracts include a window of about 30 days at the end of each term, during which you can choose to withdraw your money without incurring a financial penalty. In the case of installment premium annuities, a new term may begin each time you pay the premium.
This is what determines the percentage of the increase in the index that will then be used to figure out the index-linked interest. For instance, if the index has changed by 10% and your participation rate is set at 70%, the index-linked interest rate will be 7%.
Insurance companies can change the participation rate for new annuities frequently, sometimes as often as daily. That means the participation rate for your annuity can be different from the participation rate of the same annuity issued at a different date. In most cases, the company will guarantee the initial participation rate over a specific period, anywhere from a year to the entire term.
Participation rates often feature limits to prevent them from being set any higher or lower than a certain maximum or minimum value.
Cap Rate or Cap
Some annuity contracts feature an upper limit on the amount of index-linked interest an annuity can earn. This limit is referred to as the cap rate or cap.
The floor is the inverse of the cap rate and signifies the minimum index-linked interest your annuity can accrue. The floor is most commonly set at 0%, though not every annuity contract specifies a floor on fixed index-linked interest.
Some annuity contracts stipulate that an average value will be used to calculate index-linked interest rather than examining the specific value on a given date. This averaging may occur at the beginning of the term, the conclusion of the term, or at any point in between.
Compound interest means that any index-linked interest your annuity earns during a term can earn interest in the future. Some annuity contracts feature simple interest instead, which means interest accrued during the term is added at the end of the term but does not itself accrue interest.
In some cases, the index-linked interest is determined by taking a specific percentage off the top of any observed change. This percentage can be referred to as the “margin,” “spread,” or “administrative fee,” and it can either replace or be added to the participation rate.
For example, the change in the index is computed to be 10%. Your annuity contract might stipulate that 2.25% of this value might be subtracted as an administrative fee. The company won’t subtract this fee if the interest rate is a negative value.
Vesting is another term for crediting, and it usually refers to the index that is paid on an annuity. Some annuities won’t vest any interest if you take all of your money out early, or will vest only some of it. The vesting percentage usually increases as the term continues and is always 100% when it reaches its conclusion.
In the face of rising inflation, the best thing you can do to protect your financial future after retirement is to understand your options. This is where we come in.
For more detailed advice and guidance on different types of annuities and how certain investments can help guard your fixed income from the ravages of inflation, make an appointment with a licensed professional at Annuity Associates.