Fixed Index Annuity – do any of you have experience with them? Update on page 2

I’ve never been an annuity guy. But, a good friend who I have discussed investments with over the years and whose opinion I respect told me about an annuity I wasn’t aware of, Fixed Index Annuity. From what he told me and a little research it works something like this. The annuity invests your principle in bonds. The interest earned on the bonds is not returned to the investor. It is used to purchase a stock index fund such as S&P 500 or options in the index fund. If the index goes up you make money but if the index goes down you don’t lose your principle.

The general idea is you don’t lose money in a down year but make money in the up years.

He said the life of the annuity is 5 to 10 years. At the end you get your principle and any profit out and can invest in another one if you want. There is a penalty for taking your money out early except that you can take up to 10% out during any year with no penalty.

I have an appointment with his advisor next Friday and have thought of a few questions. I was hoping some of you have looked into fixed index annuities or might let me know of other questions to ask. Here is what I have so far.

-What type of bonds do they invest in? It must be individual bonds because bond funds do loose value when interest rates rise. There is always the danger of default of some individual bonds. How can they guarantee that your principle will never lose value if invested in bonds?

-These annuities must have an inception date and a date certain ending date. How do they determine what the date is that they close out their position in the index fund and take a new position? They have to close out the position to “cash out” during up years. I need to know how this works because at the end of the year you have more income from the bonds that needs to be invested.

-What are the fees charged by the agent and by the administrator? Supposedly the insurance company pays the agent a commission.

-Would there be an advantage to laddering, for example, $5000 every 6 months vs. investing $50,000 at one time? I believe $5000 is the minimum investment.

-Wouldn’t it be better to wait for a big correction before getting into one of these? The money I am considering is sitting in a money market fund (outside of an IRA) earning about $50 per year. So even if I got in near the top of the market I wouldn’t miss much income. I might even make out better with the principle invested in bonds.

Thanks in advance for any thoughtful insights you might be able to pass along.