Fixed Annuity vs. Fixed Indexed Annuity

By Chris Gavrel, Licensed Agent · 4 min read

Fixed and fixed indexed annuities are both built to protect your principal from market losses. Where they differ is how they credit interest. Here’s how to tell them apart.

Fixed annuity: the simple one

A fixed annuity credits a declared interest rate. The insurance company tells you the rate up front, and it’s guaranteed for a set period. After that period, the rate may reset, but the contract will have a minimum rate it can’t go below.

It’s a lot like knowing what you’ll earn ahead of time. No surprises, up or down.

Fixed indexed annuity: linked to an index

A fixed indexed annuity (FIA) credits interest based partly on how a market index performs, such as a stock market index. Your money isn’t invested directly in the market. Instead:

When the index goes up, you may earn interest, up to certain limits
When the index goes down, your credited interest is generally zero for that period, not negative
Interest that has been credited is typically locked in

The limits that shape an FIA

Term	What it means
Cap	The maximum interest you can earn in a period, even if the index rises more.
Participation rate	The percentage of the index’s gain used to figure your interest.
Spread or margin	A percentage subtracted from the index gain before interest is credited.
Crediting method	How and when the index change is measured, such as yearly point-to-point.

Insurers can usually change caps and participation rates at renewal, within limits set in the contract. Index returns generally don’t include dividends.

Side by side

	Fixed annuity	Fixed indexed annuity
How interest is credited	Declared rate	Based on index performance, subject to limits
Predictability	High. You know the rate	Lower. It varies year to year
Potential interest	Set by the rate	Can be higher or lower than a fixed rate in a given year
Protection from index losses	Not tied to an index	Yes, generally zero credited in down years
Complexity	Simple	More moving parts
Surrender charges	Yes, during the surrender period	Yes, during the surrender period, often longer

Which might fit you?

A fixed annuity may appeal to people who want simplicity and to know exactly what they’ll earn.

A fixed indexed annuity may appeal to people who want protection from market losses but would like a shot at more interest in good years. You do have to be OK with some years of zero interest and with more complicated terms.

Neither is “better.” It depends on your goals, timeline, and comfort level.

Income riders

Many FIAs offer optional income riders that can provide lifetime income. These often carry an annual fee. Some riders use an “income base” that’s only used to figure your income. It isn’t cash you can withdraw. Make sure you understand the difference.

Important things to know

Both types usually have surrender charges if you take out more than the free-withdrawal amount early
Withdrawals before age 59½ may face an additional 10% federal tax (IRS Publication 575: Pension and Annuity Income)
Illustrations of future interest are hypothetical, not promises
Annuity guarantees are backed by the financial strength and claims-paying ability of the issuing insurance company. Annuities are not bank deposits and are not FDIC insured.

FINRA offers a helpful independent guide on indexed annuities (FINRA: The Complicated Risks and Rewards of Indexed Annuities).

Questions to ask

What is the current rate or cap, and how can it change?
How long is the surrender period, and what are the charges?
What is the minimum guaranteed value?
Are there rider fees?
Is this suitable for my age, timeline, and other savings?

A simple illustration of how index crediting works

Here’s a made-up example, not based on any real product. Say an FIA has a 6% annual cap. In a year when the index goes up 10%, the annuity would credit 6%. In a year when the index goes up 3%, it would credit 3%. In a year when the index falls 15%, it would credit 0%. No interest that year, but no loss from the drop either. A fixed annuity paying a declared rate would credit that same rate each year no matter what the index did. Actual caps, rates, and results vary and can change.

Don’t compare on rate alone

It’s tempting to choose whichever product shows the highest number. But the length of the surrender period, the free-withdrawal amount, the minimum guarantees, any rider fees, and the financial strength of the insurer matter just as much. Look at the whole contract, not just the headline rate.

If you’d like to compare options, I’m glad to lay them out side by side in plain language.

Sources

This article is for general educational purposes only and is not legal, tax, or financial advice. Coverage, pricing, and availability vary by age, health, state, and carrier.