If you owned stocks or stock mutual funds at the start of the 21st century, you no doubt felt the financial pain of the market’s crash.
Between the stock market’s peak in March 2000 to its subsequent bottom in October 2002, the combined market value of companies traded on the New York Stock Exchange and NASDAQ fell by $9.3 trillion – the equivalent of more than $31,000 for every man, woman and child in America.
While the stock market has recovered slightly since 2002, that’s little solace to those whose portfolios were decimated by the market’s drastic drop. Many consumers who are especially risk-averse, such as retirees and those nearing retirement, are wary of ever returning to the stock market, given its inherent risks.
Yet during the same time as the stock market freefall, nearly all consumers who purchased a relatively new type of fixed annuity, called an index annuity (IA), did not lose a dime of their original principal. This prompts consumers to ask, “How is this possible?”

A Newer Type of Fixed Annuity
The reason IA owners can feel secure about not losing their principal is because 100 percent of the principal in an IA is backed by the financial strength of the issuing insurance company. Furthermore, IA owners earn a guaranteed minimum rate of return and potentially can earn more, depending on their annuity’s index-linked rate of return.
An IA, like all fixed annuities, is an insurance contract between the issuing company and purchaser. In exchange for holding the IA contract for a specified period of time, usually seven to 12 years, the purchaser can expect to receive tax-deferred gains and a lump-sum payment or series of income payments when the owner elects a payout schedule as provided in the contract.
The issuing insurance company links the IA’s interest rate to a select external index. Most IAs have interest returns linked to the S&P 500 Index, although some are linked to other indices. The index-linked interest rate earned is usually a percentage of the growth of the index. However, IAs are not securities, nor should they be considered a direct alternative to securities.
Index annuities typically earn interest rates that vary from 40 percent to as much as 125 percent of the index to which they are linked. For instance, an 80 percent rate would mean that you would receive 80 percent of your index’s growth. Thus, a $100,000 index annuity with an index growth of 10 percent and a rate of 80 percent would earn 8 percent, or $8,000 in its first year.

Longer-Term Horizon
Because of their multiple-year holding period (similar to that of a long-term CD or bond), IAs are most suitable for consumers with longer-term financial goals, such as retirement. IAs are not meant for short-term purposes.
However, knowing that consumers may occasionally wish to tap their IAs, most IA issuers allow some sort of annual withdrawal, up to a set amount, without assessing withdrawal charges. But it is more beneficial to leave your IA intact for the contract term specified, since the interest you earn is tax-deferred until withdrawal.

No Up-Front Sales Charge
Sold in amounts as little as $5,000 and offered by some of the most highly ranked and financially sound companies in the insurance industry, IAs also are unique because purchasers do not pay any up-front sales charge. When you buy an IA, 100 percent of your principal goes directly into the IA. Your insurance agent is compensated solely by the issuing insurance company.

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