Fixed Index Annuity Basics

Shawn Plummer

CEO, The Annuity Expert

Americans are living longer and spending more time in retirement. That means many of us may be wondering if our retirement money will last and if we’ll be able to enjoy our same standard of living as the years go by. In addition to social security, a pension, 401k or IRA, a fixed index annuity may be good to have in your financial mix. Since they are tied to a market index, fixed indexed annuities offer the opportunity for growth as the market rises. At the same time, they protect your principal from the uncertainty of market volatility.

When you think about the years ahead, what are you looking forward to? For most people, the answer is a nice balance of favorite past times and new adventures, busy and tranquil moments.

Balance is also important in your financial life, between reward and risk, nest egg preservation, and growth. No one knows what the future holds. That’s why indexed annuities attract retirement savers’ attention looking to achieve balance and peace of mind, no matter what happens in the financial markets.

In 2008 and 2009, Americans lost an unprecedented amount of retirement savings because of stock market volatility. Those who owned index annuities lost nothing. So what are annuities, and specifically indexed annuities?

Like all annuities, they earn tax-deferred interest to help your money grow even more and they can give you a steady stream of guaranteed income for life. We all have different needs in retirement so before you talk with your insurance agent it’s best to have a clear picture of what you want from a fixed indexed annuity.

Like many other longer-term financial products, annuities have a surrender fee for early withdrawal. The terms of which depend on your contract.

Fixed vs Variable Annuity

There are two categories of annuities, fixed and variable.

With variable, the consumer assumes the risk for the annuities value. And with fixed, the insurance company assumes the risk. An indexed annuity is a type of fixed annuity . Still, it has a distinct way of calculating annual interest using a formula based on changes in stock, bond, or commodity index performance.

The index is used as an external benchmark. You do not actually invest in it, while the interest you earn, and when you get it, depends on your particular contract features. Generally, indexed annuities have an interest rate floor, a participation rate, and a cap determining the amount of interest you earn.

Fixed index annuity pros and cons

An index annuity generally earns interest based on a “rate” that always remains somewhere between the floor and the cap.

  • It does not rise above the cap, even if the index goes higher.
  • Conversely, it never falls below zero, even if the index goes way down. So the value of your money will never decline for as long as it is in the annuity, but it can increase with a rising index.

Once interest is credited, it also can never be lost due to interest rate adjustments or negative market fluctuations, and it may even compound. That means more potential growth than other fixed annuities or simple savings plans and less risk than variable annuities and other more volatile investments, bringing some balance to your retirement plan.

Like all annuities, the index type offers tax-deferred growth. You aren’t taxed on interest earnings while your money stays in the annuity. The process of choosing an index annuity can also give you peace of mind.

These financial products are backed by some of the world’s largest, most reputable insurance companies, and can only be sold by a licensed insurance professional who is mandated to receive product-specific training. Companies are required, in most cases, by their state’s insurance department, to ensure that every indexed annuity sale is suitable for the customer’s age, financial situation, and goals. And while agents are paid commissions, no sales compensation is ever deducted from your annuity principal.

Now that you know the basics about index annuities, learn more here.

Questions To Ask

  1. How much retirement income do you need beyond the resources you already have? Consider things like where you want to live, your monthly expenses, and activities you want to pursue in retirement.
  2. How and when you’d like to access the money in your annuity, one lump sum or payments over time, more money in the near term or down the road.
  3. What is your tolerance for financial risk? Are many of your other financial assets in high-risk products like stocks or in safer products like indexed annuities?
  4. What are the terms and conditions for receiving payments?
  5. Are there extra charges for withdrawals if something significant comes up in your life? What, if any, penalties must you pay for ending your contract early?

Questions Answered

Additional Reading

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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