Fixed vs fixed index annuity: how do they work and who do they fit?

Annuities can be helpful, and they can be confusing. Two of the most common types, fixed and fixed index, sound alike. They work differently. This guide explains both in plain words, with the trade-offs.

Epic Life Group is an independent agency. It is not a carrier. Its licensed agents compare carriers by phone. This guide is general education, not tax, legal, or investment advice. No return is promised. Product availability and suitability rules depend on the carrier and your state.

What is an annuity?

An annuity is a contract with an insurance company. You pay the insurer, and it agrees to pay you later, either as a lump sum or as income. Investor.gov describes annuities as contracts that can be used for retirement savings and income. See the glossary for annuity.

Annuities come in two phases. In the accumulation phase, you pay in and the value grows. In the payout phase, you may take income. Read more in accumulation phase and annuitization. Our page on annuities gives an overview.

What is the difference between a fixed annuity and a fixed index annuity?

A fixed annuity credits a stated interest rate. A fixed index annuity credits interest tied to an index, subject to limits. Both are issued by insurers. Neither is a direct investment in stocks.

See the glossary entries fixed annuity, fixed-indexed annuity, and multi-year guaranteed annuity. A multi-year guaranteed annuity, often called a MYGA, is a fixed annuity with a rate guaranteed for several years.

How does a fixed annuity work?

A fixed annuity works by paying a declared interest rate for a set period. The NAIC’s Buyer’s Guide to Fixed Deferred Annuities covers these contracts. After the guarantee period, the insurer may declare a new rate, subject to any contract minimum.

Ask these questions.

• How long is the initial rate guaranteed?
• What is the minimum rate after that?
• What is the surrender period and schedule?
• How much can I withdraw each year with no charge?
• Is there a market value adjustment?

How does a fixed index annuity work?

A fixed index annuity credits interest based on an index, using a formula. The NAIC’s buyer’s guide says FIAs earn interest based on changes in a market index and that the guaranteed rate cannot fall below zero. You do not invest directly in the index.

Insurers use different crediting methods, such as annual point-to-point, monthly averaging, or monthly point-to-point. Participation rates and caps then limit how much of the index gain is credited. The NAIC also notes that taking money out before an index term ends may mean you do not get all the index-linked interest for that term.

FINRA defines a cap rate as an upper limit on how much of the index’s upside you can receive. A participation rate sets your return to a specified percent of the index’s return. For example, an 80 percent rate gives 80 cents per dollar of index gain.

A simple example with made-up numbers

This is only an illustration, not a forecast. Say the index gains 10% in a year, the participation rate is 70%, and the cap is 6%. 70% of 10% is 7%, which is above the cap, so the credit is 6%. If the index loses 8% and the floor is 0%, the credit is 0%.

Rates, caps, and formulas can change from year to year, and some are not guaranteed after an initial period. Ask which terms are fixed for the whole surrender period.

What are surrender charges, and how long do they last?

A surrender charge is a fee if you withdraw more than the free amount during the surrender period. Investor.gov says the amount withdrawn may be subject to a surrender charge if you withdraw within a certain number of years, and that these fees generally decline over time. An SEC investor bulletin describes surrender periods that often last six to ten years, or even longer.

The SEC and FINRA both warn that surrender charges can mean you receive less than the amount you paid in. See surrender charge, surrender period, and free withdrawal.

Taking money before age 59 and a half can also bring a federal tax penalty on top of income tax. That is general information. Ask a tax professional about your situation.

What is an income rider?

An income rider is an optional feature that creates a stream of income, often for a fee. The rider may track its own value, which can differ from the cash value you can withdraw. So the “income base” may look larger than the amount you can take as a lump sum.

Ask the following.

1. What is the rider fee, and is it taken from the account?
2. How is the income base calculated, and what rate does it grow at?
3. What age can I start income, and what does the payment equal?
4. What if I withdraw extra? Does it reduce the income?
5. What happens to the rider at death?

See income rider. Compare the rider with simply buying a payout annuity later. Both paths have costs and trade-offs.

How safe are annuity guarantees?

Annuity guarantees depend on the insurer. Annuities are not FDIC insured, so you rely on the insurer’s ability to pay. The SEC’s bulletin lists an insurer becoming unable to meet its obligations as a risk for indexed annuities.

State guaranty associations may offer limited protection if an insurer fails. Limits vary by state and are not a substitute for choosing a financially strong insurer. Ask your agent for the insurer’s financial strength ratings from independent rating agencies. Ask your state department of insurance about guaranty association coverage.

Fixed vs fixed index: which one fits what?

Which fits depends on your goals, your timeline, and your comfort with complexity. This table is a starting point, not advice.

Annuities may be a poor fit if you may need the funds in the near term, if you are buying them only for a bonus or a promised high number, or if you do not understand the contract. Also compare annuities with other ways to save. Suitability rules apply to annuity sales in many states, and agents must act in your best interest under the NAIC standard in states that adopted it. See best interest standard and suitability.

What questions should I ask before I buy?

Ask in writing and keep the answers. Use this list.

1. What type of annuity is this, and who is the insurer?
2. What is my guaranteed rate or floor, and for how long?
3. What are the caps, participation rates, and spreads? Are they guaranteed?
4. What is the surrender schedule? What can I withdraw free each year?
5. What fees apply, including the rider?
6. How will I be taxed on withdrawals? (Ask a tax professional.)
7. How is the agent paid, and does it change the recommendation?
8. How long is the free look period? See free look period.

What happens to an annuity when the owner dies?

What happens at death depends on the contract. Many annuities pay a death benefit to the named beneficiary, often at least the contract value, but terms vary. Some pay differently after income payments have started. Ask how the contract treats death in the accumulation phase and the payout phase.

Check these points.

• Who is the beneficiary, and is there a contingent beneficiary? See beneficiary.
• Are surrender charges waived at death?
• If income has started, does it continue to a beneficiary?
• Does a rider change the death benefit?

Taxes at death can be complicated. A tax professional can help. Keep the contract where your family can find it.

How do I compare two annuity offers?

Compare them line by line. Put the two contracts side by side and fill in the same blanks: insurer, rate or formula, how long it is guaranteed, surrender schedule, free withdrawal, fees, and rider terms. A high headline number often comes with a longer surrender period or a lower guarantee later. Ask the agent to explain the difference. If the answer is vague, ask for it in writing. Take time and avoid deciding under pressure.

Next step

A licensed Epic Life agent can explain fixed and fixed index annuities, compare carriers, and answer your questions. Please bring your timeline and questions. Request a call at get a quote. You can read more in our FAQ and about page.

This guide is general education. It is not tax, legal, or investment advice. No return is promised. Guarantees depend on the insurer. Coverage, rates, and eligibility depend on the carrier, your age, and your state.