Fixed and fixed indexed annuities are both insurance contracts that credit interest without putting your money in the stock market. Both grow tax-deferred and can be turned into income later. They differ in how interest is credited. This guide walks through how each one works, the features that vary from contract to contract, and the questions to ask before you sign anything.
The basics both types share
An annuity is a contract with an insurance company. You pay money in, either a lump sum or over time, and the contract can pay it back later, including as a stream of income. Deferred annuities have two phases: an accumulation phase, when the money grows, and a payout phase (Investor.gov: Annuities). Fixed and fixed indexed annuities are not investments in the stock market, and they are not bank deposits or FDIC insured. Their guarantees are backed by the claims-paying ability of the issuing insurer. Our annuities guide covers the basics.
How a fixed annuity works
A fixed annuity credits interest at a rate set by the insurance company. Many contracts declare a rate for an initial period, sometimes several years, and then set a renewal rate. According to the SEC's investor education site, fixed annuities guarantee at least a minimum interest rate during the accumulation phase; the insurer may credit more than the minimum, but only the minimum is guaranteed (Investor.gov).
The appeal is predictability: you know the rate for the period you are in. The trade-off is that the rate does not rise if markets do well. Some multi-year versions lock in a rate for the full surrender period.
How a fixed indexed annuity works
A fixed indexed annuity (FIA) credits interest based partly on how a market index, such as the S&P 500, changes over a set term, usually a year. The NAIC explains that the insurer uses a formula to turn the index change into interest, and that once interest is credited for a term, it is usually locked in (NAIC Buyer's Guide for Deferred Annuities). If the index goes down over the term, zero interest is added, so the contract value does not drop because of the index, as long as you do not withdraw money. You are not investing directly in the market or the index.
Several features determine how much of an index gain you actually receive. All of them vary by contract, and insurers can often change them for future terms within limits in the contract:
- Cap rate: the maximum interest credited for a term.
- Participation rate: the share of the index's increase used to figure your interest.
- Spread (or margin): a percentage subtracted from the index gain before interest is credited.
- Crediting method: how the index change is measured, such as annual point-to-point or monthly averaging.
Index changes usually exclude dividends. FINRA points out that these features mean indexed returns can be well below the index's gain in strong years, and suggests checking whether the insurer can change them (FINRA). Many FIAs also offer a fixed-rate account, so you can split your money between the two.
Side by side
| Compare | Fixed annuity | Fixed indexed annuity |
|---|---|---|
| How interest is set | A rate declared by the insurer, with a guaranteed minimum | A formula based partly on an index, within caps, participation rates, or spreads |
| Know the rate in advance? | Yes, for the current period | No; interest is figured at the end of each term |
| If the index falls | Not affected | Zero interest for that term, not a loss from the index |
| Complexity | Simpler | More moving parts |
| Surrender charges | Common | Common |
| Regulated as | Insurance (state) | Insurance (state) |
Features vary by insurer, product, and state.
Not the same as variable annuities or RILAs
Two other types sound similar but carry market risk. Variable annuities put your money in investment subaccounts, and registered index-linked annuities (RILAs) can credit negative returns when the index falls. Both are securities regulated by the SEC. The SEC does not regulate fixed indexed annuities, which guarantee the credited interest will never be less than zero (Investor.gov: Indexed annuities). Make sure you know which type you are being shown.
Costs and limits to understand
- Surrender charges. Most fixed and indexed annuities charge a fee if you take out more than a set amount during the first several years. The charge usually goes down each year until the surrender period ends. Many contracts let you withdraw a small amount, often up to 10% a year, without the charge (NAIC).
- Market value adjustment (MVA). Some contracts adjust the amount you receive on an early withdrawal up or down based on interest rate changes.
- Rider fees. Optional benefits, such as a lifetime income rider, usually cost extra.
- Taxes. Growth is tax-deferred, but withdrawals of earnings are taxed as ordinary income, and withdrawals before age 59½ may face a 10% IRS tax penalty on top of regular tax (Investor.gov).
Which one fits?
A fixed annuity may suit someone who values knowing their rate and wants something simple. A fixed indexed annuity may suit someone who wants protection from index losses and is comfortable with interest that varies year to year and with more complex rules. Neither is a fit for money you may need in the next few years, because of surrender charges. The right choice depends on your timeline, income needs, other savings, and taxes, and a licensed agent should review all of that with you before recommending anything.
Questions to ask before you buy
- How long is the surrender period, and what is the charge each year?
- How much can I withdraw each year without a charge?
- For an FIA: what are the current cap, participation rate, or spread, and what are the guaranteed minimums or maximums?
- Does the contract have a market value adjustment?
- Are there rider fees, and what do I get for them?
- How long is the free-look period to cancel after I receive the contract? (It varies by state.)
The bottom line
Fixed annuities credit a declared rate; fixed indexed annuities credit interest based partly on an index, within limits that vary and can change. Neither loses value because an index falls, though surrender charges, fees, and taxes can reduce what you receive, and both usually have surrender charges for the first several years. Neither is an investment in the market, and guarantees depend on the issuing insurer. Request a free consultation to compare options, or read our annuities guide. If you are weighing life insurance with cash value instead, see IUL pros and cons and how whole life cash value works.
Frequently asked questions
What is a cap rate on a fixed indexed annuity?
A cap rate is the maximum interest a fixed indexed annuity will credit for an index term, even if the index rises more. Caps vary by contract, and the insurer can often change them for future terms within limits stated in the contract.
What is a free-look period on an annuity?
A free-look period is a set number of days after you receive the contract during which you can cancel without a surrender charge. The length is set by state law, often 10 to 30 days, and should be stated in the contract.
Can I take money out of an annuity early?
Usually yes, but there may be costs. Many contracts let you withdraw a small amount each year, often up to 10%, without a surrender charge. Larger withdrawals during the surrender period can trigger charges, and withdrawals of earnings before age 59 1/2 may face a 10% IRS tax penalty plus regular income tax.
Is a fixed indexed annuity the same as a variable annuity?
No. A fixed indexed annuity is an insurance product whose credited interest can't be less than zero. A variable annuity invests in subaccounts and can lose value with the market, and it is a security regulated by the SEC.
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This article is general and educational, not an offer to sell insurance or financial, tax, or legal advice. Coverage, benefits, and availability vary by carrier, product, and state, and all coverage is subject to underwriting.