Before Moving Your CD or 401(k) Into a Fixed Indexed Annuity, Ask These Questions

You may hear a pitch along these lines:

“You get market upside without the downside.”

There is an important truth behind that pitch—but also an important omission.

With a conventional fixed indexed annuity, the interest credited based on an index generally cannot fall below zero because the index itself went down. You don't simply absorb the stock market's losses.

But that does not mean you receive the full return of the market index when it rises.

Your credited interest can be limited by the contract's:

Participation rate — the percentage of an index gain used in calculating your credited interest.

Cap rate — the maximum interest that can be credited under a particular index strategy.

Spread or margin — an amount subtracted from the index change before interest is credited.

The NAIC explains all three mechanisms and notes that participation rates, caps and spreads can significantly affect how much interest an indexed annuity actually credits.

So if a sales presentation shows a stock-market index gaining 12%, don't assume your annuity earned 12%.

Ask what the contract would actually have credited.

This may be the most important issue for an older buyer.

A deferred annuity can have a surrender-charge period lasting many years.

If you withdraw more than the amount permitted under the contract during that period, you may face a surrender charge. The NAIC says surrender charges are generally a percentage of the amount withdrawn and usually decline over time. Many contracts permit a limited amount—often around 10% per year—to be withdrawn without the surrender charge, but the actual rules vary by contract.

That matters enormously if you're 75 or 80 and suddenly need money for:

assisted living

home health care

a major medical expense

home repairs

helping a spouse

long-term care

an unexpected family emergency

The money may still belong to you.

But ownership isn't the same thing as liquidity.

Before signing, ask:

“Exactly how much of my money can I access each year without a surrender charge?”

And:

“What happens if I need substantially more?”

An FIA can provide contractual guarantees, but every guarantee has to be examined in the context of the contract.

The insurance company—not the stock market—is ultimately responsible for the contractual guarantees.

That means another question belongs on your list:

How financially strong is the insurance company issuing this annuity?

California's Department of Insurance advises consumers to check the financial strength of the insurance company before buying.

And remember:

“No market loss” doesn't mean “no financial risk.”

You can still face surrender charges, limited liquidity, inflation risk, opportunity cost and contract restrictions.

A 40-year-old and an 80-year-old can look at exactly the same annuity and reasonably reach very different conclusions.

Why?

Because their need for liquidity may be completely different.

If you're 40 and don't expect to need the money for 15 years, a long surrender period may be less concerning.

If you're 78 and that money represents a large portion of your available savings, tying it up for years is a very different proposition.

California's Department of Insurance specifically tells seniors to consider when they will need income, how long they expect to leave money in an annuity and whether they will be able to access their money when they need it.

The question isn't simply whether the annuity is a good product.

It's whether this annuity is appropriate for you.

Moving money from a 401(k) into an annuity can have legitimate reasons.

But don't let the rollover itself make the annuity sound automatically better.

Before moving retirement money, ask:

Why should I move this money at all?

Then ask:

Why this annuity?

And:

What would I be giving up by leaving the money where it is?

Compare the costs, investment choices, liquidity, guarantees and tax consequences.

If someone is recommending that you move a large retirement balance into an FIA, ask them to explain the recommendation in writing and explain why the proposed annuity is appropriate for your particular situation.

Here's a question many consumers don't ask:

“How much will you be paid if I buy this annuity?”

You should.

The NAIC's annuity best-interest framework specifically addresses conflicts of interest and requires recommendations to put the consumer's interest ahead of the agent's or insurer's financial interest.

A commission doesn't automatically mean the recommendation is bad.

But if someone is asking you to move $100,000, $250,000 or $500,000 of your savings, you deserve to understand the financial incentive behind the recommendation.

Ask for the answer in writing.

1. How long is the surrender-charge period? Get the exact number of years.

2. What is the surrender charge in each year? Ask for the complete schedule.

3. How much can I withdraw each year without a surrender charge? Get the exact dollar amount or percentage.

4. What happens if I need the money for assisted living, home care or a medical emergency? Don't accept a vague answer. Ask for the specific contract provision.

5. What is the participation rate? And can the insurer change it?

6. What is the cap rate? What is the maximum interest that can be credited under the index strategy you're considering?

7. Is there a spread or margin? If so, how does it affect the amount credited?

8. What would this contract have credited if the index gained 5%, 10% and 20%? Ask for actual examples using the proposed contract—not a generic illustration.

9. What fees and other charges apply? Ask about contract fees, withdrawal charges, premium taxes, riders and other charges that could affect your money.

10. How much will you be paid if I buy this? Ask the agent to disclose the compensation and material conflicts involved.

11. Why is this better for me than keeping my CD or retirement account? The answer should be specific to your circumstances.

12. Can I take the contract home and have someone independent review it before I sign? You should never need to make a major financial decision under pressure.

A free-look period gives you time after receiving the contract to review it and decide whether to keep it.

But the rules vary by state.

For example, California provides a 30-day free-look period for seniors buying annuities. California's Department of Insurance advises seniors to use that period, not sign anything they don't understand and consider having a trusted person review the contract.

Don't assume your state's rules are identical.

Find out before you buy how long your free-look period is and exactly how you exercise it.

And don't treat the free-look period as a substitute for doing your homework beforehand.

This may be the simplest advice in the entire article:

You do not have to sign today.

You don't have to move your 401(k) because someone tells you the opportunity is available only now.

You don't have to surrender your CD because someone has shown you an impressive market chart.

You don't have to make a six-figure financial decision at your kitchen table while a salesperson is waiting for your signature.

California's Department of Insurance tells consumers not to be pressured, to obtain proposals in writing and to consider having a trusted family member, friend or advisor participate in the discussion.

Take the contract home. Read it. Compare it. Ask questions.

If necessary, walk away.

A fixed indexed annuity isn't automatically a bad product. But a long surrender period can make it a poor fit for money you may need soon.

Don't be dazzled by a chart showing what the stock market did.

Ask what your contract would actually have credited.

Don't focus only on the guarantee.

Ask how much of your money you can actually access, when you can access it and what it will cost.

And before moving a CD, 401(k), IRA or other savings into an FIA, get the surrender schedule, withdrawal rules, participation rate, cap, spread, fees and salesperson compensation in writing.

Then take your time.

If the product really is right for you, it should still be right after you've had time to think about it.