What is a Fixed Index Annuity?
A fixed index annuity is a type of fixed annuity that credits interest based on the performance of an external stock market index providing the potential to earn higher interest rates than offered by a fixed annuity.
Shopping for a fixed index annuity may seem overwhelming but it doesn’t have to. In our Ultimate Guide to Fixed Index Annuities, we will cover everything you’ll need to know to make an informed purchasing decision.
Ultimate Guide to Index Annuities
Fixed index annuities provide an opportunity to earn higher interest rates than a fixed annuity or any other investment product offering principal protection.
A fixed index annuity can help you build a source of guaranteed lifetime income, save for a specific retirement goal, or leave a legacy for your loved ones.
Fixed Index Annuities Explained
A fixed index annuity is a contract between you and an insurance company that may help you reach your long-term financial goals. In exchange for your premium payment, the insurance company provides you income, either starting immediately or at some time in the future.
NOTE: You may also hear of a fixed index annuity referred to as a:
- Equity Indexed Annuity
- Indexed Annuity
- Hybrid Annuity
- Index Annuity
Benefits of an Index Annuity
The primary benefits of an index annuity are: tax deferral, potential for higher interest rates, and principal protection from downturns in the financial markets.
A Fixed Index Annuity Grows Tax-Deferred
Under current federal income tax law, any interest earned in your fixed index annuity contract is tax deferred. You don’t have to pay ordinary income taxes on any taxable portion until you begin receiving money from your contract. Withdrawals are taxed as ordinary income and, if taken prior to age 59½, a 10% federal additional tax may apply.
An Index Annuity Provides Upside Potential in Low-Interest Rate Environments
Fixed index annuities provide an opportunity for potential interest growth based on changes in one or more indexes. Because of this potential indexed interest, FIAs provide a unique opportunity for accumulation.
And since the interest your contract earns is tax-deferred, it may accumulate assets faster. In addition to potential indexed interest, FIAs can offer you an option to receive fixed interest.
An Index Annuity Provides Principal Protection
Fixed index annuities offer you a level of protection you may find reassuring. That protection can benefit you in three separate ways:
• Accumulation: Your principal and credited interest are protected against market downturns.
• Guaranteed income: You can be protected from the possibility of outliving your assets.
• Death benefit: If you pass away before annuity payments begin, a fixed index annuity may help you provide for your loved ones.
Current Index Annuity Rates
Yr 1 | Yr 2+
|SILAC||Denali 14||B+||7||2.50||10% / 10%||7 yrs|
|Atlantic Coast Life||Accumulation Protector Plus with Rate|
|B++||5||6||3.20||0% / 10%||10 yrs|
|Sentinel Security Life Ins. Co.||Accumulation Protector Plus with Rate|
|B++||5||6||3.20||0% / 5%||10 yrs|
|SILAC||Denali 10||B+||5.5||2.75||0% / 5%||10 yrs|
|Oceanview Life and Annuity||Harbourview FIA 10||A-|
|0% / 10%|
0% / 5%
|Great American Life Ins. Co.||American Legend 7||A+||7 yrs|
|Lincoln Financial Group||Lincoln OptiBlend 10||A+||5.25||1.90||10% / 10%||10 yrs|
|Nassau Life and Annuity Company||Nassau Growth Annuity 10 Group A||B+||Up to 3.00||5.25||2.85||5% / 5%||10 yrs|
|Fidelity & Guaranty Life||Prosperity Elite 10 Protection||A-||up to 2.50||5.25||1.00||0% / 10%||10 yrs|
|Fidelity & Guaranty Life||Prosperity Elite 14 Enhancement||A-||up to 4.00||5.25||1.00||0% / 10%||14 yrs|
Fixed Index Annuities Offer Tax-Deferral
During the accumulation phase of your contract, any interest credited is tax-deferred. If you purchase your fixed index annuity with after-tax dollars, you will only pay ordinary income taxes on your earnings – not on your premium payments – when you begin withdrawing money.
Tax-deferred growth, compounded over time, may increase the amount of savings and income your fixed index annuity generates for your retirement.
There are not any government-imposed contribution limits for a fixed index annuity, unlike traditional IRAs and 401(k)s. Because of this, indexed annuities may often be a good choice if you want to save more than IRAs and 401(k)s allow and still enjoy tax-deferred growth potential.
Purchasing an index annuity within a retirement plan that already provides tax deferral results in no additional tax benefit. So the decision to use an index annuity to fund a qualified plan should be based upon features other than tax deferrals, such as lifetime income options or the guaranteed death benefit.
Fixed Index Annuity Tax-Deferral Example:
The below chart shows how tax-deferral can impact the value of an indexed annuity over time. The chart assumes a $100,000 index annuity grows at 4% compounded annually and compares the index annuity’s account value 20 years later with and without tax-deferral.
As you’ll notice the index annuity growing tax deferred for 20 years has a value $10,000 greater than a taxable investment.
Disclosure: This example assumes a 33% ordinary income tax assessed annually on taxable earnings and at the period ending on indexed annuity tax-deferred earnings. Actual tax rates may vary from this example for different taxpayers and assets (e.g., capital gains and qualified dividend income). The actual performance of your contract will also vary.
Hypothetical interest is not guaranteed and does not represent the performance of any particular index annuity. If a withdrawal or distribution is taken, the tax-deferred earnings would be reduced by income taxes on any interest and, if taken prior to age 59½, a 10% IRS tax penalty may apply.
Consider your personal retirement plan and income tax brackets, both current and anticipated, when making financial decisions.
Indexed Annuity Owners are More Confident in Retirement
Investors who own annuities, across all wealth segments, are more confident that their savings and investments won’t run out, even if they live into their 90s.¹
- “Singlehood in Retirement: A Study of Retirees,” LIMRA Secure Retirement Institute (March 2018)
- How Does a Fixed Index Annuity Work?
When you purchase a fixed index annuity, you can allocate its value to one or more chosen indexes. At your index annuity’s contract anniversary the performance of your selected index is measured and one of the index annuity crediting method so is applied to determine how much interest is applied to your index annuity.
If the stock market index performs your index annuity will automatically be credited interest, subject to a participation rate, a cap, or spread. Interest credited to an index annuity is locked in annually, and cannot be lost due to any future stock market index declines.
If the result is negative, nothing happens – and that can be good news! The way an indexed annuity works is your annuity’s account value cannot decline due to market volatility or loss. This feature is called annual reset; the graph below will help you to visualize this concept.
Index Annuity Interest Crediting Methods
Many Index Annuities Credit Interest using the Annual Point to Point Crediting Method
This indexed annuity crediting method compares index values from two points in time: the closing value at the end of a term to the closing value on the first day of a term. If the result is positive, interest is credited, subject to the cap, spread, or participation rate. If the result is negative, the credited interest rate is 0%.
Calculating the Interest Credited to an Index Annuity:
Calculate the Specified Market Index Performance:
The below graph shows a hypothetical index value change from 100,000 on contract issue to 107,000 on contract anniversary. This represents an annual index performance of 7%.
Determine how much interest is credited to your index annuity:
Index Annuity Example: Assuming a 10.80% annual Index Performance and a 5% Cap, 75% participation rate, and 3.00% spread.
Index Annuity Cap: 100% of index performance credited to index annuity up to the cap rate.
Result: Index annuity receives 5% interest credited (100% up to 5% cap).
Participation rate: Index performance multiplied by the participation rate.
Result: Index annuity receives 7.50% interest credited (10% X 75% par rate).
Spread The index performance minus the spread.
Result: Index Annuity receives 7.00% interest credited (10% – 3% spread).
No single index annuity crediting method consistently delivers the most interest under all market conditions.
Stock Market Indexes Available in an Index Annuity
An Index Annuity Lifetime Income & Legacy Planning Opportunities
Indexed Annuities Provide Principal Protection
An index annuity offers a safe and steady way to grow your retirement savings with the potential to earn higher interest rates than otherwise available from an investment with principal protection.
An Index Annuity Can Provide Guaranteed Lifetime Income
An annuity can provide you income for as long as you live through annuitization,* which converts your assets into an income stream at no extra cost, or via an optional benefit rider available for an additional cost.
Lifetime Income Payments May Increase Based on Specified Market Index Performance
Some of the optional index annuity income riders provide income payments that can increase to assist with inflation throughout retirement.
The longer you want to turn on your index annuity lifetime the higher your lifetime income payments will be. In addition, there are options that will increase your income payments based on the performance of a market index even after you begin taking income.
Index Annuities Enable you to Provide a Legacy
Best Index Annuity Companies (by sales)
Source: LIMRA Secure Retirement Institute U.S. Individual Fixed Index Annuity Sales Survey
Index Annuity Advantages
- Tax deferral
- Principal protection
- Lifetime income options
- Investment flexibility
- Upside Potential based on Market
- Beneficiary protection
- Spousal opportunities
Pros and Cons of an Index Annuity
Index Annuity Pros
- Backed by highly rated, state-regulated insurance companies
- They grow tax-deferred (tax deferral)
- Participate in a portion of stock market gains without the risk of loss
- You can make unlimited contributions unlike a 401(k) or IRA
- The death benefit may be paid directly to the beneficiaries, bypassing probate
Can be turned into guaranteed lifetime income you cannot outlive
Index Annuity Cons
- Eventually, they are taxed as ordinary income tax rates, unlike stocks which are treated as capital gains.
- A withdrawal before age 59 1/2 results in a 10% IRS penalty.
- During the annuity contract (usually 5 to 10 years) you only have access to your annual free withdrawal amount which is almost always 10% of the account value.
- There are many different insurance companies offering fixed indexed annuities and each company’s product is a little bit different.
- FDIC – fixed indexed annuities are not FDIC insured.
Fixed Index Annuity vs. Variable Annuity
The line graph below compares the sales of variable annuities (VA) and fixed index annuities (FIA) in the United States from 2006 to 2020. Variable annuities are represented by the blue line while the red line represents indexed annuity sales.
As you can see, variable annuities have decreased in popularity significantly while fixed index annuities are becoming increasingly popular. VA sales decreased from approximately $185 Billion in 2006 to ~$100 Billion in 2020 while FIA sales increased from ~$75 Billion to ~$120 Billion during the same timeframe.
2016 marked the first year that individual fixed index annuity sales surpassed variable annuity sales in the United States. This is due in large part to the high cost and fees associate with variable annuities vs. low or no fees of an index annuity.
Typical Variable Annuity Fees
- M&E (mortality and expense) – average around .50%
- Sub-Account Fees – average 1.00%
- Optional Rider Fees (income rider or death benefit rider) – Average 1.00% each
- No Fees for Base Index Annuity
- Optional Indexed Annuity Rider Fees – Average 1.00%
If you are considering purchasing a variable annuity you will find the U.S. Securities and Exchange Commission’s (SEC) Variable Annuities: What You Should Know investor tips.
An indexed annuity’s credited interest is calculated annually and determined by the performance of a specified stock market index. However, you are not directly invested in the market which means your index annuity account value won’t decrease due to a potential market downturn.
Fixed Index Annuity Terminology
10% Free Withdrawals
Annual free withdrawals up to 10% of your index annuity’s account value annually without penalty.
Interest Only Free Withdrawals
Withdraw your index annuity’s accumulated interest annually without penalty.
Extended Care Waiver Rider
If you are confined to a nursing home or long-term care facility for at least 90 consecutive days (after the first contract year), this waiver provides you with the option to withdraw 100% of your index annuity’s account value without penalty.
Terminal Illness Rider
After the first contract year, if you are diagnosed by a physician as having a terminal illness, you have the option to withdraw up to 100% of your indexed annuity’s value without penalty.
Our Annuity Terms Glossary has a comprehensive list of index annuity terms and definitions written in plain English.
Index Annuity Frequently Asked Questions
Related Index Annuity Articles
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Annuities are distributed by My Annuity Store, Inc. Guarantees are subject to the claims-paying ability of the insurer. My Annuity Store, Inc. does not advise clients on the purchase of non-fixed annuity products. The information presented here is not intended to be a recommendation to purchase a fixed annuity (MYGA), fixed index annuity(FIA), variable annuity (VA), registered index-linked annuity (RILA), immediate annuity (SPIA), longevity annuity, or Qualified Longevity Annuity Contract (QLAC).
The contract features described may not be current and may not apply in the state in which you reside. Insurance companies often issue contracts that are ‘state-specific. Insurance companies also change their products and information often and without notice. Annuities are subject to the terms and conditions of the specific contract issued by the insurer, are not FDIC or NCUA insured, are not bank guaranteed, may lose value, and are not a deposit. Please call (855) 583-1104 if you have any questions or concerns.
The information presented here is not a representation regarding the suitability of any concept or product(s) for an individual and it does not provide tax or legal advice. You should always consult your own financial planning, tax, and legal advisors to determine if a fixed annuity, fixed index annuity, annuity with long-term care rider, immediate annuity, longevity annuity, or Qualified Longevity Annuity Contract are suitable in your financial situation.