Fixed index annuities offer a conservative way to benefit from gains in the market without putting your principal at risk. Additional benefits include tax-deferred growth and guaranteed minimum returns. But there are also caps on growth you can experience, and contracts can be complex.
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A fixed index annuity is a long-term savings product whose return is based on a stock market index. While fixed index annuities are often tied to major market indexes such as the S&P 500, they can also be tied to less common indexes depending on the financial institution or insurer that sells them.
Unlike stocks and other types of annuities, fixed index annuities provide security against losses if the market falls. A contract typically ensures that you will never lose your principal in exchange for a cap on potential earnings. Similar to other annuities, they are intended to provide a steady income stream during retirement and can be used to round out a 60/40 investment portfolio.
But along with a cap on earnings, fixed index annuities are generally illiquid, and contracts can be complex.
It’s essential to weigh the pros and cons of a fixed index annuity before determining if one is right for you.
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Fixed index annuities are generally safe products because they are designed to protect investors from market downturns while still allowing them to benefit from upswings.
Buying a fixed index annuity is typically structured in a format where you see limited losses when the index it’s tied to declines but benefit from a percentage of the growth when that index improves.
Different products offer several crediting strategies, with options ranging from different indexes to selecting floors and caps that make sense for you.
A floor places a percentage limit on how much you can lose — and a minimum on how much you can earn. For example, if the floor is set at 5% and the index decreases by 12%, you would only lose 5% of your contract value.
Another potential benefit of a fixed index annuity is that the company issuing the product may include a minimum return guarantee.
This means that — even if the index your annuity is tied to declines — you can still experience a small, guaranteed amount of growth. This adds an extra level of safety to the product, guaranteeing you at least some level of return.
In some ways, fixed index annuities operate similarly to CDs by presenting a safe way to grow your money at a solid rate. The main difference, of course, is that fixed index annuities base their rate of growth on an index while CDs generally offer a fixed rate.
That chance to participate in the market’s upside allows fixed index annuities to offer potentially higher returns than CDs.
Additionally, the tax deferral component offered through fixed index annuities is not available with a CD. This means your money can grow even more than it would in a CD since your interest can go untaxed while it grows.
Indexed Annuities have a 3.27% average annual return*
*Based on a study from 2007-2012
CDs have a 1.76% average annual return*
*Based on 12-month CDs from 12/31/2001-12/31/2020
Tax-deferral is a significant benefit of opting for a fixed index annuity since it’s a feature not commonly available through many financial products.
When you purchase an annuity, you will only owe taxes once you withdraw money from the product. This is a notable difference from a CD, where you pay tax on the annual interest earned.
Since the money in your annuity account is untaxed, you have the opportunity for even more growth since that money can continue to compound on itself uninhibited through the course of your contract term.
