Fixed indexed annuities are a type of indexed annuity where your money grows based on a stock market index, but you still have some guarantees in the forms of floors, so there’s little investment risk. Fixed indexed annuities combine features of fixed annuities and indexed annuities.
What is a fixed indexed annuity (FIA)?
Fixed indexed annuities (FIAs) are annuities that are based on a market index — for example, the S&P 500 or the Nasdaq 100. Many FIAs are based on well-known indexes but depending on your insurer, you may be able to choose from a wide variety of indexes. [1] You may also hear the term “equity-indexed annuity” (EIA) or just “indexed annuity” to refer to a fixed indexed annuity — they’re essentially the same product.
The key feature of FIAs is that they offer a minimum guarantee value (MGV). In exchange, FIAs also limit your earnings at a certain point.
Learn more about other types of annuities
How do FIAs work?
Most FIAs are a type of deferred annuity — which means you make premium payments over a number of years, during the so-called accumulation period. This is when your principal grows.
Accumulation period
You can structure your annuity to have the accumulation period that works for you when you buy your contract.
FIAs have two different subaccounts in which your principal can grow: an index tracking account and a fixed interest rate account. You — as the investor — can choose to contribute to both accounts, or just the index tracking.
The index tracking account typically offers a 0% floor, so you won’t lose any of your account value.
The fixed interest rate account offers a set rate, determined by the insurer and recalibrated once per year.
What is the impact of interest rate changes on your annuity?
For example, if you allocate 50% of your funds in the fixed interest rate account, only those funds would be affected by the guaranteed fixed index rate. The remaining 50% of the funds would earn based on the designated index (but wouldn’t lose beyond the floor of 0%).
Separate from how your premiums are invested, FIAs also have a minimum guarantee value (MGV), or guaranteed minimum surrender value (GMSV), that kicks in if for some reason your account value doesn’t meet the minimum guarantee (which is usually 87.5% of your principal at 1% to 3% interest). [2]
The MGV feature rarely comes into play, but if you were to pass away shortly after buying your annuity or the stock market suffers multiple years in a row, this provides you with a safeguard.
Do annuities affect financial aid and other benefits?
Annuitization or payout period
After the accumulation period, you can start receiving payments — during the payout phase, also known as annuitization. The amount of money you’ll receive per payment will be determined by the terms of your contract. Most often, annuities pay out for the life of the annuitant. You’re guaranteed to receive payments as long as you live, and once you pass away, the payments stop.
You can typically add on features and pay extra to have more guarantees — for example, a life with period certain annuity pays out for the life of the annuitant with an added guarantee of a certain number of years (usually 10 to 20), but if the annuitant passes away prematurely, a beneficiary can receive payments for the remainder of the guaranteed period.
Learn more about life only vs. period certain annuities
Participation rates
With FIAs, your insurer may set a participation rate, which dictates how much of the index’s return gets credited to your earnings. For example, if an insurer’s participation rate is 70%, and the index you selected earned 10%, your annuity will be credited with 7% interest.
Floors
FIAs can also come with floors, which minimize the amount of money you can lose, regardless of how your chosen index performs. Many fixed indexed annuities have a floor of 0% [3] — which means in a worst case scenario during an economic downturn, you’ll break even. Here you’d have “upside market potential with no downside risk,” says Amy Shirk, sales associate at Policygenius.
Can you withdraw money from your annuity?
Caps
On the other hand, FIAs have caps, which can limit your earnings. This helps the insurer buffer against risk in exchange for offering you downside protection. Let’s say your cap is 6% and your chosen index earns 8% in a given year — that means you’ll only get 6% interest.
With any type of indexed annuity, you’ll want to make sure to read the terms of your contract carefully. Fixed indexed annuities can have both caps and participation rates, which can collectively limit your earnings if the market is performing well.
Surrender period & other fees
Like other types of annuities, FIAs have surrender periods to discourage you from giving up your contract shortly after you bought it — if you want to take money from your account during this time, you’ll have to pay a penalty fee.
The surrender period varies from insurer to insurer — it could last for five to 10 years or sometimes longer. Your surrender fees may decrease over time, meaning you’d pay more of a penalty for withdrawals in year one than you’d pay in year three.
Fixed index annuities may also include commissions, administrative fees, and mortality expense fees, which insurers use to buffer against loss. Collectively, these fees can reduce your earnings and impact how much your distributions will be. Fees vary by insurer, so be sure to read your contract thoroughly before buying.
Learn more about how annuities work
Tax implications
FIAs offer tax-deferred growth — you won’t pay taxes on your earnings until you withdraw money from your annuity. This also means that you’ll face an additional penalty if you withdraw funds before you reach age 59 ½. [4]
Learn more about qualified annuities
What are the pros & cons of fixed indexed annuities (FIAs)?
FIAs offer the potential for higher interest growth than fixed annuities, but with more guarantees than other subtypes of indexed annuities or variable annuities. Because there’s little investment risk, they can be good for “a client’s ‘safe’ money,” says Shirk of Policygenius.
Pros
Tax-deferral. Like other types of annuities, you won’t pay taxes on your earnings until you take withdrawals, which helps increase your year-over-year growth.
Protection against inflation. FIAs offer you a higher projected return than fixed annuities, which can help protect you against inflation. FIAs also protect you from your principal losing value beyond a certain threshold.
Less risk than other investment vehicles. FIA caps and floors help limit your losses, so you can minimize your investment risk.
Cons
Uncertainty. Since your FIA is based on a market index, you don’t know exactly what your returns will be each year, even if you have principal protection.
Capped returns. During years where returns are high, you may be limited by the caps on your FIA.
Surrender fees. You’ll have to pay penalty fees if you surrender your annuity before the designated surrender period is up.
Learn more about fixed annuities vs. variable annuities
What should you consider before buying a fixed indexed annuity?
Fixed indexed annuities give you the potential to earn a modest amount of interest while also protecting your principal. You should consider your investment goals and risk tolerance to make sure that an FIA aligns with your financial priorities.
Can you lose money in an annuity?
Your age
Most fixed indexed annuities are deferred annuity contracts, meaning they take time to accumulate and delay the time you start receiving payments. If you don’t have many years left until retirement, an immediate annuity may be better suited to you.
Your investment goals
If you want to add another investment vehicle to your portfolio that offers fairly low risk, a FIA can help you protect principal while also giving you the opportunity to earn more interest than you would with a fixed annuity.
Can annuities be used as a collateral for a loan?
Your risk tolerance
FIAs take on slightly more risk than fixed annuities with a guaranteed interest rate, because you don’t know exactly how the market index will perform. However, you still have some guarantees when it comes to your principal.
If you have a high risk tolerance, you may want to consider an annuity with more growth potential instead — in this case, you could look at other types of indexed annuities.
Are annuities a good investment?
Who should consider FIAs?
If you’re looking for some potential to earn interest, but you also want to protect your principal, a FIA may work for you. These are a fairly low-risk way to supplement your income later in life. If you’re not certain which type of annuity will work best for your overall goals, speaking with a financial advisor can help.
How does an annuity fit into your overall retirement plan?
