Fixed Index Annuity Pros and Cons

Thinking about a fixed indexed annuity for your retirement? When considering a fixed index annuity, or any annuity contract for that matter, it’s helpful to think through all the pros and cons of your options before making a decision.

Nothing is perfect for every financial situation or contingency. Fixed index annuities are no exception in that regard. Rather, a strategic mix of financial vehicles and strategies will help create a balanced, personal retirement plan that fits your needs and situation.

A fixed index annuity can give your plan a strong foundation with its contractual guarantees. Your money can grow more in an indexed annuity than it might in other fixed-type annuities with guaranteed rates. However, this kind of annuity has some areas where it’s not as strong as other annuities or financial vehicles are.

What Is a Fixed Index Annuity?

Like other annuities, a fixed indexed annuity is a contract with a life insurance company. As the “fixed” in its name suggests, the indexed annuity protects your money and interest earnings against market risk.

A fixed index annuity can potentially earn more interest than a traditional fixed annuity or a multi-year guarantee annuity. The fixed indexed annuity is tied to an underlying benchmark index. A commonly used benchmark is the S&P 500 price index.

When the underlying index goes up, your contract earns interest that is based on a portion of that index increase. When the index goes down, your existing contract value stays the same. You effectively earn “zero” for that period instead of negative interest being credited to your contract.

In exchange for this protection against index losses, the growth potential of your fixed index annuity does have some limits. How much interest your money earns is determined by caps, participation rates, and spreads, so the growth isn’t “unlimited” or even meant to compete at the same level with equity market returns (despite some annuity ads promising you just that).

What Are the Pros and Cons of a Fixed Index Annuity?

If you are thinking about different annuity options, here are some fixed index annuity pros and cons to remember as you weigh your choices. Some quick ones are below.

Pros of a Fixed Index Annuity:

  • Strong protection of principal – backed by sturdy, state-regulated life insurance companies
  • Growth potential based on a linked benchmark index, like the S&P 500 price index
  • Money grows tax-deferred while inside the annuity
  • Can earn more interest than other fixed-type annuities, bonds, CDs, and other fixed-interest vehicles
  • Helps contract holders avoid market risk
  • Most fixed index annuities don’t have fees or expenses
  • Can give guaranteed lifetime income and other contractual guarantees for people’s unique situations
  • Have some liquidity with flexible withdrawals
  • Provide death benefit to heirs if someone passes away without using all the money in the contract
  • Can bypass probate and its costs
  • No IRS code limits on how much money you can put into an annuity, unlike with 401(k) plans and IRAs

Cons of a Fixed Index Annuity:

  • Taking money out before age 59.5 incurs a 10% IRS early withdrawal penalty
  • Surrender charges for withdrawals in excess of free withdrawal amount or when contract is ended before maturity
  • The money taken out is taxed at ordinary income tax rates
  • Money in an annuity received by beneficiaries is generally taxable
  • Don’t have coverage by the FDIC or NCUA
  • With principal protection, interest-earning potential can be limited
  • Not as much growth potential as variable annuities, stocks, or other market-based investments
  • Can have years of zero interest earnings when benchmark index is down
  • In times when the annuity earns zero percent, possible for surrender charges or add-on rider benefit fees to offset zero credited interest
  • Participation rates, caps, spreads, and other factors used to calculate interest earnings can change annually
  • Some indexed annuities or rider benefits come with fees, but many indexed annuities don’t

Now, what are some advantages and disadvantages of a fixed index annuity that it’s good to understand? Let’s do a deep dive into some of the more involved “for’s” and “against’s” with this type of annuity product.

Pro #1: Earn More Interest Than Elsewhere

Fixed index annuities are designed to let you earn more interest than you might with a CD, a traditional fixed annuity, or even bonds.

Historically, fixed index annuities have seen more growth potential than these other assets. If you want growth for your money that is more than what the bank offers, but still have some protection, this sort of annuity might be what you are looking for.

Pro #2: Zero Is the Hero

When the underlying index drops in value, you earn zero interest for that period. Your principal and already-earned interest money remains intact.

You continue to benefit from this, too. Fixed index annuities have a variety of “crediting strategies,” or ways that your money can earn interest. Your annuity will have certain features that reset monthly, annually, or possibly over a longer period, depending on the crediting strategies that you choose.

Pro #3: Guaranteed Lifetime Income

Like all other types of annuities, fixed index annuities can pay you a guaranteed income stream. This guaranteed income can be received for a certain period or for life.

What is also nice is a fixed index annuity can give you some flexibility in how you receive these payments. Many contracts come with income riders that can you let turn the payments off and on when you need the income. They may also come with a fee, so be sure to ask for any details if you are considering options with this add-on benefit.

Pro #4: Tax-Advantaged Growth

Fixed index annuities also provide a tax benefit for growing your retirement money. They can provide tax-deferred growth for helping you accumulate more retirement savings.  The premiums that you pay into your contract aren’t deductible, but there is no limit to the amount of money that can be placed inside a contract.

This money is tax-deferred as long as it’s inside the annuity. On the backend, your withdrawals will be taxed as ordinary income.

Pro #5: Relatively Low or No Fees

Fixed indexed annuities don’t have management fees or, for that matter, other investment-based fees that you find in variable annuities.

Fees are built into the contract design with how the insurer can limit your growth potential. However, you also enjoy principal protection in the times of index losses as well. Some contracts do have fees or expenses, but most indexed annuity contracts don’t.

Let your financial professional know if this is an important factor for you in your annuity buying decisions.

Con #1: Moving Parts

Fixed indexed annuities can have lots of moving parts, from how they earn interest to the lifetime income they pay out and how all of this might be calculated by the insurer.

Make sure you find a financial professional who knows their annuity contracts, who acts in your best interest, and who can walk through everything before you make a decision.

Con #2: Not Designed for Market Returns

Fixed indexed annuities aren’t designed to compete with the market. Generally, they are meant as vehicles with growth potential that might be superior to many fixed-income asset types.

The interest you earn from an underlying index doesn’t include dividends. However, since fixed index annuities aren’t a direct investment in the market, this is hardly an actual factor anyway.

Cons #3: Payout Calculations Can Be Tricky

How the insurer calculates payouts to you can be fairly involved. For one, there is an annuity “income value.” This is the internal number that the insurance company’s actuaries use for payout calculations to you.

Just this part alone can be complex. Make sure you understand how this feature might work in any fixed index annuity contracts you are exploring.

Con #4: Some Liquidity Available

Fixed index annuities have liquidity, but it’s limited. Like other annuities, fixed indexed contracts do have some provisions for liquidity.

However, they also come with early withdrawal penalties and surrender charges if you take out too much money too early.

Con #5: Some Contracts and Riders Have Fees

As stated earlier, some fixed indexed annuities come with riders or add-on features that have additional fees or charges.

Some contracts also have fees for base features, although this is quite rare. This question of fees isn’t prevalent among fixed index annuities overall, but it does vary from one insurance company to another and from contract to contract. To be sure, it’s good to have a clear idea of how much your fixed indexed annuity might cost you.

How Do You Find the Right Annuity for You?

Work with an experienced, independent financial professional to explore your options. They can help you to determine whether an annuity makes sense – and which one will be best for you going forward.

By working with an independent financial representative, you can have access to annuity products from many life insurance companies. This also gives your financial professional much more leeway in the solutions that they can shop around for and offer you.

They also tend to have broader product knowledge, and that can help in finding the right indexed annuity for your situation (if it makes sense for you).

Different Contracts for Different Situations

At the very least, remember this. Like other types of annuities, different fixed index annuity contracts are built for different needs. Some indexed annuities are designed primarily to provide long-term growth potential. Meanwhile, others are geared to provide a superior stream of income over time.

Your financial professional will discuss your situation with you in depth, understand your needs, and help you find competitive ones based on what fits your circumstances.

Need Someone to Help You?

What if you are looking for a financial professional to guide you in this process? No sweat. Many independent practitioners are available at to assist you.

Get started with our “Find a Financial Professional” section to connect with someone directly. You can request an initial appointment to go over your questions and explore a working relationship. Should you need a personal referral, call us at 877.476.9723.

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