How does a fixed index annuity differ from a fixed annuity?
The main differences between a fixed annuity and a fixed index annuity are the risk levels and how interest is calculated.
- With a fixed interest rate, you know in advance how much your annuity will grow and how much income it will pay out. This predictability is particularly helpful for people with a conservative risk tolerance.
- The earnings may come in fixed payments over a set number of years, fixed payments for the rest of your life or in a lump-sum payment.
- Earnings will not be taxed until
withdrawals begin .
- All or some of the interest is linked to a market index, such as the S&P 500, the Nasdaq 100 or the Dow Jones Industrial Average, subject to a cap. This creates the potential for more growth if the index performs well—and conversely offers protection from loss due to poor index performance.
- Although your annuity’s interest is tied to the index's performance, your money is not directly invested in the market. This means that if the index your annuity is tied to doesn’t perform well, your annuity doesn’t lose its value due to market volatility.
Here’s a look at the key differences between these two types of annuities in more detail.
Fixed annuities are considered a lower risk than fixed index annuities
Fixed annuities have a guaranteed minimum interest rate so you will receive some interest each year. A fixed index annuity has an interest feature tied to a specified index, but subject to a cap. If the index has negative performance, you will receive no interest that year.
Fixed annuities are considered a lower risk annuity
Fixed annuities may tend to pose less financial risk than other types of annuities and investment products whose values rise and fall with the market. The predictable, guaranteed interest rate is one of the most attractive features of a fixed annuity. And with certain types of fixed annuities, like a
As with most annuities, if you want to withdraw money from your fixed annuity earlier than scheduled, you’ll likely incur a penalty, or surrender charge—which sometimes can be hefty. Depending on when you make the withdrawal and how much you take out, the penalty may even result in a loss of value in your annuity. In addition, withdrawals made prior to age 59 ½ may be subject to a 10 percent federal tax penalty based on the fact the annuity is tax-deferred.
Fixed index annuities have slightly more risk
The interest, if any, on a fixed index annuity is tied to an index. Since the interest is tied to a stock market index, the interest credited will either benefit or suffer, based on market performance. A fixed index annuity can be an attractive option when you want to balance growth and stability in your retirement portfolio.
Like a fixed annuity, fixed index annuities are not particularly liquid investments. If you need to withdraw funds earlier than the annuity’s specified time frame you may face surrender charges as high as 10%.
Fixed annuities offer a fixed interest rate while fixed index annuities offer variable rates
The fixed interest rate, the built-in guarantee, is one of the most notable differences between fixed and fixed index annuities.
Fixed annuities guarantee a specific interest rate for a specified period, never to fall below the guaranteed minimum interest rate
The minimum guaranteed interest rate on a fixed annuity may be lower than other types of annuities. You are trading potentially benefiting from market upswings and/or not keeping pace with inflation.
Fixed index annuity interest is tied to the performance of a specific index
Fixed index annuities have the benefit of potentially offering a higher guaranteed interest rate when an index performs well, and principal protection when the index suffers losses. In exchange for this protection against losses, there may be a cap on the maximum earnings you can receive, or your earnings may be limited to a percentage (for example, 70%) of the index’s adjusted value.
Comparing fixed annuities & fixed index annuities
| Fixed annuity | Fixed index annuity | |
| How it works | Provide a minimum guaranteed interest rate for the life of your annuity contract or for specified periods of time (MYGAs). It typically also has a current interest rate as declared by the insurance company. | Interest, if any, is tied to a specified index, up to an annual cap. For example, a product could have an index account where interest is based on how the S&P 500® Index performs, subject to an annual cap. |
| Taxation on growth | Tax-deferred | Tax-deferred |
| Risk/principal protection | Lower risk | Lower risk for principal protection, but interest credited fluctuates and may even drop to 0%. |
| Tried to index performance? | No | No |
| Earnings | Value grows at a set interest rate. This feature protects against the risk of market losses. However, it also limits potential gains, even when the market is up. | Interest earned is dependent upon index performance which can be positively and negatively impacted. |
