FIAs are insurance company contracts specifically designed for an exact purpose: give savers the chance to benefit when the stock market rises, but protect them from losses if the market falls.
That goal is possible because of guarantee features which insurance companies are legally permitted to use, but which investment companies (such as mutual fund and ETF issuers) are not. In the US, banks and insurance companies are the only ones allowed to make financial guarantees. Insurance companies have taken full advantage of this special standing in the design of FIAs, to offer something which, from a risk perspective, their competitors in the fund and securities industries simply cannot match.
Terms vary by issuer, and there are a lot of variations on the theme out there in the market place. But the basic proposition is that the account can only move in one direction: up. If the market goes up one year, so does the account, based on some pre-set formula. If the market has a down year, the account doesn’t receive any interest for that year, but neither does it lose value. It’s important to note that this preservation of account value is not limited to the amount paid in to initiate the annuity, but usually extends to all amounts credited in previous years, too. So once the account rises, that becomes the new floor value under which the guarantee will not let it fall due to market activity.
FIAs are a first-line consideration for those looking to have a shot at earning more than bonds or CDs, but who don’t want to take on the risks of the stock market to get those higher yields. FIAs have been widely available in the market place for a couple of decades now, and for the most part, as an asset class, have delivered pretty solidly. Average earnings have consistently run several points higher than other “safe money” options, and done so in many cases with lower levels of risk. The risk protection benefits become especially apparent during times of significant downturn (like the Tech Bubble in 2001, and the Housing bubble in 2008). FIA owners largely avoided the huge drawdowns that market investors encountered; and withdrawals made during those down years did not permanently damage their portfolios the way that stock investors suffered.
As a result of this combination of features, FIAs are a great candidate for rollover transfers from 401(k) plans at the time of retirement. But they are also a good fit for transfers from other investment holdings which are not in IRAs or other retirement plans. That’s because the annuity structure itself has built in tax deferral features, so taxes are typically not due during the accumulation phase. Although every situation is different, in practice the use of a FIA as one component of the portfolio is a good fit more often than not.