Fixed Indexed Annuity Basics
Understand how principal protection, index linked interest crediting, liquidity and future income options can work together inside an insurance contract.
What is a fixed indexed annuity?
A fixed indexed annuity is an insurance contract designed to protect contract value from direct stock market losses while providing an opportunity to earn interest based in part on the performance of a referenced market index. Your money is not invested directly in the index or in stocks.
The insurer calculates interest according to the crediting strategy selected in the contract. That distinction matters. An index can rise by one amount while the interest credited to an annuity is different because the contract may use a cap, participation rate, spread or another crediting method.
Why people consider an indexed annuity
The primary appeal is the combination of principal protection and accumulation potential. For someone approaching retirement, avoiding a major market loss can become increasingly important because there may be less time to recover before withdrawals begin.
An indexed annuity can also provide tax deferred accumulation. Taxes are generally deferred until taxable amounts are withdrawn. Tax treatment depends on how the contract is funded and individual circumstances, so qualified tax advice should be obtained when appropriate.
How index linked crediting works
The contract identifies one or more crediting strategies. At the end of a crediting period, the insurer applies the contract formula to determine whether interest is credited. A cap may limit the maximum credited rate. A participation rate may determine how much of an index increase is used in the calculation. A spread may be deducted from the measured index change.
A zero percent index floor generally means a negative index result does not create a negative index credit. It does not mean every part of the contract is guaranteed never to decline. Withdrawals, surrender charges and optional rider costs can still affect contract value.
Liquidity deserves as much attention as growth
Annuities are designed as longer term contracts. Most provide some access to contract value, but withdrawals above available free withdrawal provisions can trigger surrender charges during the surrender period. Withdrawals may also affect future income benefits and may have tax consequences.
Before moving money, identify what portion must remain liquid for emergencies, near term purchases and ordinary living expenses. Money that may be needed soon generally should not be placed into a contract with significant surrender restrictions.
Retirement income options
Some contracts offer optional income riders or other methods of creating future income. The income calculation may use a separate benefit value that is not the same as cash value. Rider charges, withdrawal percentages and benefit rules vary significantly by contract.
The useful question is not simply which contract shows the largest income number. The comparison should consider when income is expected to begin, access to principal, survivor needs, inflation concerns, rider costs and what happens if circumstances change.
Who should evaluate an indexed annuity?
An evaluation can be appropriate for someone who has retirement assets, wants protection from direct market losses, has sufficient liquid reserves outside the annuity and can commit funds for the applicable time horizon. It may also be relevant when reviewing an old 401(k), IRA, maturing fixed account or an existing annuity.
Questions worth asking before you move money
- How long is the surrender period?
- How much can I withdraw without a surrender charge?
- Which values are guaranteed and which can change?
- How are caps, participation rates or spreads set?
- Is an income rider necessary for my objective and what does it cost?
- What happens to the contract and any income benefit when I die?
- How does this option compare with simply leaving the money where it is?
Frequently asked questions
Can a fixed indexed annuity lose value when the stock market falls?
The contract value is not directly invested in the referenced index. Index declines generally do not create a negative index credit, although withdrawals, surrender charges, rider costs and other contract provisions can reduce value.
Does an indexed annuity receive the full return of an index?
No. Interest is calculated under the contract crediting method. Caps, participation rates, spreads and other limits can affect the amount credited.
When can an indexed annuity make sense?
It may be worth evaluating when principal protection, tax deferred accumulation, a defined time horizon or future income planning is more important than direct market participation.
What should I compare before choosing one?
Compare the surrender period, withdrawal provisions, crediting strategies, guarantees, optional rider costs, income features and the financial strength of the issuing insurer.
Review your retirement priorities first.
Use the SummitLine Retirement and Annuity Planning Guide to organize your assets, liquidity needs, time horizon and income objectives before comparing contracts.
Get the Free GuideEducational information only. Annuities are insurance products and are not bank deposits or FDIC insured. Guarantees depend on the claims paying ability of the issuing insurer. This page is not tax, legal, investment or individualized insurance advice. Product features and availability vary by carrier and state.