Understanding Fixed Indexed Annuities

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Fact Sheet for Consumers:

Understanding Fixed Indexed Annuities

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Put simply, a Fixed Indexed Annuity (FIA) is a fixed annuity that credits interest based on the change in the price of a market index, rather than a fixed rate of interest. The interest periodically credited to the annuity will be less than the return of the market index, but the annuity will also have a guaranteed minimum value. So if the index gains 10% the interest credited to the annuity may only be 5%, but if the index drops by 10% the annuity may not be credited with any interest for that period but will not lose value (provided it is not surrendered before the end of the surrender charge period).

IMPORTANT TERMS AND DEFINITIONS

• Market Index – an index that measures the price changes of a large, overall market, such as the S&P 500 or the Vanguard Total Bond Market Index.

• Indexing Method – the calculation applied to the change in the index to determine the interest crediting rate applied to the annuity. Dividends are not included in the calculation of the index return.

• Index Term – the period of time over which the index change is measured and the index-linked interest is calculated and credited to the annuity. One year terms are most common, though terms may be of any length.

• Participation Rate – The participation rate is expressed as a percentage and is used to calculate the amount of any increase in the index that will be credited to the annuity. For example, if the index increases 10% and the participation rate is 60%, the index-linked interest rate credited to the annuity is 6% (10% x 60% = 6%)

• Cap rate – A cap rate limits the index-linked interest rate, setting a maximum rate of interest the annuity can earn. So if the index-linked interest rate is 6% and the cap rate is 5%, 5% will be credited to the contract. The cap rate is commonly used with a participation rate of 100%, but may also be used with participation rates that are less than 100%.

• Spread rate – As opposed to a cap rate, which limits the index-linked interest credited, the spread rate reduces the interest credited by a set percentage. Sometimes called an “asset fee,” the spread rate may be used alone, or in combination with the cap and/or participation rates. Using the same example again, with a spread rate if the index increases 10% and the spread rate is 3%, the interest credited to the annuity is 7%.

• “Uncapped” strategies – this is a newer type of crediting strategy where the amount of the index-linked interest credited to the annuity is not capped. Generally, this strategy requires that either a portion of the premium is allocated to a fixed interest account (for example 60% allocation to the index strategy and 40% to a fixed account), limiting the index-linked interest credit to only a portion of the premium; or, the index used to calculate the interest credit is an index created by the insurance company that includes some feature which limits both the upside and downside of the index, such as volatility management. The important thing to remember is that a FIA ALWAYS has some mechanism that limits the participation of the annuity in the index gain; that is the only way that the annuity can guarantee principal.

Fact Sheet for Consumers:

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• Bonus Features – Some FIAs offer bonus payments. Bonus payments are additional dollars added to the annuity by the issuer as an incentive to purchase or to encourage certain types of policyholder behavior, such as deferring withdrawals.

— Premium Bonus – A percentage of premiums paid, credited to the annuity at issue. There may be a separate charge or a higher/longer surrender charge schedule to offset the insurer’s cost of providing the credit.

— Guaranteed Lifetime Withdrawal Benefit (GLWB) Bonus – Similar to the premium bonus but only accessible if lifetime income payments are taken, not when the annuity is surrendered for cash. These payments are designed to incentivize taking withdrawals over an extended period of time vs. fully surrendering the contract.

— Annuitization Bonus – Essentially the same as the GLWB bonus but requires life annuity payments rather than lifetime withdrawals.

HOW IS FIXED INDEXED ANNUITY INTEREST CALCULATED?

The table below describes, and shows examples of, some common methods of calculating the interested credited to a FIA. It is not exhaustive, but rather is intended to show you the relationship between the change in the value of the index and the interest that may be credited to the annuity. Important: these calculations are only the first step in calculating index-linked interest. The rate that is ultimately credited to the annuity will be reduced by any participation, cap, and/or spread rates.

Indexing Method How it works

Annual Point-to-Point The change in the index is calculated from one policy anniversary to the next. Any positive change in the index value, reduced by participation, cap, or spread rates, is credited to the annuity at the end of each year and sets a new value for the annuity.

Term End Point The same as Annual Point-to-Point except the credited interest is calculated based on the change in the index value from the start to the end of the term, commonly 3 to 10 years. The index-linked interest, again subject to participation, cap, and/or spread rates, is credited to the annuity at the end of the term.

Monthly sum The change in the index is calculated each month, and both the positive changes (reduced by the participation, cap, and/or spread rate) and negative changes (not reduced by the cap rate) are added up at the end of the term. If the sum is positive it will be credited to the annuity as index-linked interest. If the sum is negative, no interest is credited but the annuity value is not reduced.

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DO FIXED INDEXED ANNUITIES CHARGE FEES?

FIAs do not have upfront charges. Surrender charges are commonly used to reimburse the insurance company for its costs to distribute the annuity, such as sales commissions, contract issuance, and policy administration. A few FIAs have an explicit charge for the crediting strategy rather than using participation, cap, or spread rates. A few states charge a premium tax, which the company pays but may then subtract from your premium payment, withdrawals, income payments, or when the annuity pays out as a death benefit.

• Surrender charges – Generally a percentage of premiums paid or the value of the annuity, assessed when a withdrawal is taken. Surrender charges are defined in a schedule that generally reduces to zero over time. While the surrender charge is in effect you may pay this charge to withdraw all or a portion of your money from the annuity. The annuity may have a limited “free withdrawal” feature that allows you to withdraw up to some fixed percentage of the annuity value or total premiums paid each year.

• Charges for Optional Benefits – Some FIAs offer an optional Guaranteed Lifetime Withdrawal Benefit (GLWB) rider for an additional fee. Generally, such benefits guarantee that withdrawals, calculated as a percentage of the annuity’s value when withdrawals begin, will continue for the lives of one or two annuity owners. GLWB riders can provide valuable benefits to help you generate income in retirement, but they usually mean additional costs. Make sure you understand how the GLWB is calculated, its cost, and any limitations or restrictions.

HOW DO FIXED INDEXED ANNUITY GUARANTEED LIFETIME WITHDRAWAL BENEFITS (GLWB) WORK?

GLWB riders are optional benefits, generally added to a FIA when the contract is issued and separately charged for through a fee deducted from the annuity’s accumulated value on a monthly, quarterly, or annual basis. GLWBs guarantee the annuity owner that a fixed percentage of the annuity’s accumulated value at the time of the first withdrawal, may be withdrawn annually (payment may be made in monthly or annual installments). The rider may also include a GLWB bonus feature, which creates a separately tracked “income value” upon which the calculation of the minimum GLWB payment is based.

For example, a FIA offering a rider with a 6% GLWB bonus feature might work as follows: (Note: this illustration is hypothetical and does not pertain to any specific investment)

Initial Premium Payment at age 55: $100,000

Income Value at age 65: $179,085 ($100,000 compounded at 6% for 10 years) 4% Annual Lifetime Withdrawal at age 65: $7,163 ($179,085 x 4%)

The annuity owner is able to withdraw a minimum of $7,163 per year for his or her lifetime, regardless of the accumulated value of the annuity. If the accumulated value is higher than the income value in year 10, then the lifetime payment would be based on that higher value. But remember, while the GLWB income value can potentially grow to exceed the actual accumulated value, the income value is ONLY used to calculate the income payment, it is not available as a cash surrender value or as a death benefit. When the annuity owner dies, the death benefit is generally equal to the remaining accumulated value, if any. Finally, bear in mind that the GLWB rider fees will reduce the accumulated value of the annuity.

DO FIXED INDEXED ANNUITIES INCLUDE DEATH BENEFITS?

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HOW DO I KNOW IF A FIXED INDEXED ANNUITY IS RIGHT FOR ME?

Selecting any financial product is a very personal decision, and deciding whether or not a product is right for you is based on too many individual factors to make broad generalizations. However, there are a few questions it may be useful to ask yourself and your advisor before making the decision to purchase a FIA.

For yourself:

Do I feel anxiety over both the potential for investment losses and the thought of “missing out” on

stock market gains? ❑ Yes ❑ No

If you want to have some measure of participation in stock market gains but cannot tolerate losses, a FIA may be a good option.

Am I comfortable with incurring surrender charges if I need to cash out of the annuity? ❑ Yes ❑ No

Surrender charges, particularly in the early years of ownership, can be high so make sure you are unlikely to need to surrender before the end of the surrender charge period.

Am I comfortable with locking up my money in the annuity for an extended period of time, perhaps

10 years or longer? ❑ Yes ❑ No

FIAs are long term investment products; make sure your time horizon matches the contract term.

Once I’ve decided to purchase a Fixed Indexed Annuity, am I comfortable that the amount I’m investing leaves me with enough money outside the annuity to cover my expenses, including potential

emergency needs? ❑ Yes ❑ No

Think carefully about both your current and potential future expenses, and whether you have enough liquidity to avoid surrendering the annuity early.

For your Advisor:

Has the contract term been explained to me? ❑ Yes ❑ No

The contract term is the period of time over which interest will be credited to the contract. Make sure your advisor explains the term length and your options at term expiration.

Have I been given a full explanation of how the contract works? ❑ Yes ❑ No

FIAs can be single or flexible premium, the free look period may vary, and the death benefit may vary among contracts. Make sure all aspects of the contract are completely explained.

Did my advisor explain which index, or indexes, are used? ❑ Yes ❑ No

While the S&P 500 is the most common index, many different indexes may be used. You may be able to select from different indexes, change later, or spread your premium across several indexes. Make sure you

understand your options.

Was the interest calculation explained, as well as when interest is credited? ❑ Yes ❑ No

Request a detailed explanation of calculations, participation rates, caps, and spreads.

Were the surrender charges explained, and was I provide with the minimum guaranteed surrender

values for each contract year? ❑ Yes ❑ No

Make sure you understand the potential consequences of having to surrender the contract early.

If the contract offers a bonus feature, was it explained? ❑ Yes ❑ No

Have your advisor explain how the bonus works, and under what conditions is it credited or forfeited.

Were all the contract charges explained? ❑ Yes ❑ No

FIAs may have charges for optional benefits, or charge asset fees instead of, or in addition to, using caps and participation rates. Make sure you understand both the amount of, and the purpose for, any fees and charges.

If there is an income benefit, was it explained to me? ❑ Yes ❑ No

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FINAL NOTES

Fixed indexed annuities offer guarantee of principal (provided the annuity is not surrendered prior to the surrender charge term and subject to the claims paying ability of the issuer), limited participation in stock, bond, and/or commodity market gains, and potentially guaranteed income for life. They are complex products that require locking up capital for extended periods to maximize their value. Before deciding to purchase a fixed indexed annuity, make sure you completely understand how the annuity works, how access to your money is limited, and how the annuity fits into your overall financial plan.

Note: Loss of principal is possible in a fixed indexed annuity if the contract is surrendered before the end of the surrender term.

Note: A fixed indexed annuity can earn interest in two ways: 1) interest that is guaranteed by the insurance company, and 2) interest that depends on how one or more market indexes perform. A fixed indexed annuity does not participate directly in any stock or equity investments. You are not buying shares of stock or an index. Dividends paid on the stocks on which the indexes are based will not increase your annuity earnings.

Note: Guaranteed lifetime withdrawal or annuity payments are subject to the claims paying ability of the issuer of the annuity contract and do not relate to the performance of the index(es) upon which the crediting rate is based.

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