Fixed Indexed Annuities: Growth & Income

A fixed indexed annuity is a variation of a traditional fixed account. Both offer safe and insured protection of your principal and interest. However, fixed indexed annuities credit interest based on the performance of the S&P 500, Dow Jones, NASDAQ, or one of the many other strategies available.

Fixed indexed annuities apply interest credits by tracking market-linked indexes. If the market (or chosen index) goes up, you participate in that growth, and interest gains are credited to your account. If the market goes down, your principal (and gains from past years) are safe from loss. Indexed annuities do not lose value. They have no direct stock market exposure like variable annuities or mutual funds.

Listed above are fixed indexed annuities offering some of the highest 1-year S&P 500 point-to-point caps. Please keep in mind that this chart is a very brief overview. Within most of these same annuities are several other indexing options to choose from. The corresponding one-year fixed account is also listed for comparison purposes.

Other factors to consider when purchasing a fixed-indexed policy are annuity premium bonuses, fees, caps, spreads, participation rates, fixed rates, and total investment options. Most indexed annuities change these factors annually. However, some FIAs lock in growth metrics at the time of purchase. We discuss indexed annuities with guaranteed rate caps here since they are more available now.

Stock and bond markets are more volatile than they once were. Investors have experienced significant losses due to big market gyrations.

Fixed-indexed annuity accounts are a popular alternative as they avoid losses during market corrections and credit meaningful interest gains during market upswings.

Indexed accounts do not credit interest daily. Rather, the insurance company leverages these interest returns by purchasing an option (or future) in the chosen index. There are usually several indices and/or crediting strategies to choose from in most FIAs.

Options contracts are tied to the S&P 500®, Dow Jones®, NASDAQ®, or one of several other market indexes chosen by you, the account owner. In fact, many carriers are offering proprietary indexes to increase returns and reduce volatility. These options either increase in value (and credit interest to your account) or expire without value if the market goes down.

Insurance companies know consumers want choices, and the best options for growth and income. With this in mind, there are many new indexes to choose from. Some are proprietary and boast of double-digit annual growth. Newer ones track gold, bitcoin, artificial intelligence companies, and emerging and foreign markets. If you can think of it, there is usually an indexed annuity that can track it for growth. It’s a very competitive landscape while interest rates have been elevated.

How Do Indexed Annuities Work?

First, imagine you have a fixed annuity. One that credits interest each year like a bank CD. But instead of crediting that interest daily to your account, it invests those gains instead. That’s what FIAs do. They take your guaranteed interest and buy futures, options, or the like. In this way, these unique annuities only leverage your interest – not your invested principal.

Only the interest gains are at risk. If that doesn’t suit your risk tolerance, then a fixed annuity might be more appropriate. But the worst-case scenario is that the market index goes down and your FIA credits no interest for that cycle.

However, when the market goes up, these accounts can credit significantly more than a traditional fixed account. In good years, many accounts have credited 20% or more. A strong average over the term of a 5-10 year FIA would be close to 9-10% under favorable market conditions.

If the chosen index (S&P 500 for example) increases over a predetermined period of time, then the value of the option contract increases. Most are set for one-year terms.

Assuming the S&P 500 index goes up, the insurance company would credit interest to your annuity at the end of the 12 month window. This interest now becomes principal, and the process would start again for another twelve-month cycle. (Some accounts offer longer interest crediting cycles in exchange for better growth opportunities.)

In contrast, if the option loses value over the chosen cycle, then no interest would be credited to the annuity. In this scenario, the option would expire without value. Your invested principal would not decrease, but there would not be any gains for that cycle.

To simplify this point: Only your fixed interest for the current yearly cycle is at risk. Your principal and interest gains from prior years are not. The account either increases or maintains its value. Any interest gains from previous years are locked in and cannot be lost in the following years. FIAs are much different than variable annuities and/or mutual funds since they do not lose value.

This is a good time to explain indexed annuity caps, spreads, and participation rates. These metrics determine your growth potential. When a fixed indexed annuity credits interest, your gains are usually subject to ceilings or limits set by the insurance company. Understanding how each one works helps you compare policies and choose the best crediting strategy for growth.

Cap rate — A cap is the maximum interest rate your annuity can earn in a given crediting period, regardless of how well the index performs. For example, if your annuity has a 12% annual cap and the S&P 500 gains 20% that year, your account is credited 12%. If the index gains 8%, you receive 8%. Caps are the most straightforward crediting method and the easiest to predict and understand. Current caps on the top FIA products can range from roughly 10% to 14% annually for one-year point-to-point strategies.

Participation rate — A participation rate determines what percentage of the index gain you receive. If your annuity has an 80% participation rate and the index gains 15%, you are credited 12% (80% of 15%). Some annuities offer 100% participation rates but pair them with a spread. Others offer participation rates above 100% on certain proprietary indexes. Some of these par rates can be near 300%. Participation rates are most commonly found on accounts using monthly or multi-year crediting strategies.

Spread — A spread, sometimes called a margin or asset fee, is a percentage subtracted from the index gain before the interest is credited. If your annuity has a 2% spread and the index gains 14%, you receive 12%. Spreads are less common than caps but are frequently used with proprietary indexes that offer higher participation potential.

It is important to know that caps, participation rates, and spreads can be renewed annually by the insurance company at the end of each crediting period. The rate in your first year is not guaranteed for the life of the contract unless stated by the insurance company. When comparing indexed annuities, always ask about the carrier’s renewal rate history — not just the first year rates.

These three annuity types are sometimes confused. Listed below are ways they are similar and different.

Fixed annuities are the simplest and most predictable accounts. They are great for conservative, risk-averse investors. MYGAs offer guaranteed returns and regular income. They require very little administration or oversight.

Fixed indexed annuities occupy a middle ground — they will not usually outperform the market in a strong bull year, but they don’t lose value when markets fall. They are more appropriate for investors seeking stronger growth but also comfortable with uneven gains.

Variable annuities offer the most growth potential but also carry the most risk and typically have the highest fees. We don’t offer variable accounts at our brokerage.

Fixed indexed annuities are not suitable for everyone, but they are a good fit for many situations. Not too hot (variable), not too cold (fixed), but maybe just right, indexed accounts are sometimes referred to as the goldilocks policies.

They work well for pre-retirees and retirees who want their invested funds to grow without the anxiety of watching a portfolio drop in poor market years. If you are within five to fifteen years of retirement, you might not be able to absorb significant losses. The principal protection offered by an FIA may be acceptable, knowing your upside growth is capped

They are also commonly used by investors rolling out of variable annuities or mutual funds that have underperformed. A first-year premium bonus — which many FIA carriers offer — can help recoup surrender charges or investment losses from other accounts.

Investors who are systematically converting a traditional IRA to a Roth IRA (Roth Conversion) often use fixed indexed annuities. This strategy keeps the funds safe while also controlling the taxable income during the transition period. Multi-year premium bonuses offered by FIAs also mitigate funds lost to taxes.

Finally, FIAs are appropriate for those who want a guaranteed lifetime income in retirement. Many policies include optional income riders. These Guaranteed Life Withdrawal Benefit (GLWB) riders provide a future income stream regardless of account performance. And they do so while preserving access to the invested principal.

Conversely, FIAs are generally not appropriate for investors with short time horizons (under five years), those who need immediate liquidity, or those comfortable with full market exposure who want to maximize long-term growth. Indexed annuities are best for account preservation, growth, and income. They are not get-rich-quick investments.

The best fixed indexed annuity might be situational. Several factors will determine the most suitable policy in any particular situation. Some offer very strong growth prospects, while others will provide the highest guaranteed income. Still others will do a little of both. State of issue, client age, bonuses, term lengths, indexing options, liquidity, and other factors all play a role.

Currently, some of our most popular FIAs for growth are offered from Axonic, Athene, GILICO, Revol One, and AuguStar. The best income options change frequently and depend on the deferral period, but a few companies show up consistently. They are Nassau, Symetra, Ameritas, Delaware Life, and Corebridge. Nationwide is known to provide both strong growth and income.

In each situation, we run side-by-side quotes with all carriers using our software to see who has the best income and growth metrics. Many of our clients use more than one annuity to achieve their needs and goals.

Indexed accounts are designed to offer higher interest returns than the best fixed annuity accounts. It’s not uncommon for these accounts to credit 7% interest (or more) when market conditions are favorable. In very good cycles, interest returns can be above 20% for just one 12-month period.

Within most index annuity accounts, you will have several indexing options to choose from. This diversification allows you to position your funds for maximum growth depending on market conditions. You don’t have to choose just one account.

Most annuities will offer different ways to capitalize on growth in the S&P 500, but it’s not uncommon to see the NASDAQ, Dow Jones, Russell 2000, European indexes, precious metals, and many other options offered as well. In fact, there are some accounts that will credit interest when the market goes down or interest rates go up. Several others offer proprietary indexing methods that have performed very well.

Fixed-indexed annuity contracts usually have a one-year fixed account option as well. The fixed account can be used in volatile market years when markets are stagnant or going down. Rather than wait out negative market cycles, you can achieve guaranteed gains in the one-year interest only fixed account. Or you can use inversion, precious metal, or rising rate strategies when in a bear market. There are always indexes crediting interest each year.

You’ll always have the ability to reallocate funds within your annuity each cycle (usually 12 months) in order to adjust to economic conditions. There can be market cycles when returns are low, but 0% will be your floor with all indexes. No matter the economy, your principal (and gains from previous years) cannot be lost when the market goes down.

All indexed annuities offer minimum guarantees to the account owner. Should the index credit no interest for the entire term of the annuity, then the principal will be multiplied by a predetermined percent as stated by the insurance company in the contract. You are then free to walk away with your principal and invest somewhere else.

It is very rare for the guaranteed minimum value to be worth more than the accumulated value, however. In almost all cases, the index performance will surpass the declared minimum guarantee. If you are more conservative in nature, a traditional fixed annuity might be best for you, but if you are willing to leverage your interest for the opportunity to capture higher returns, then an indexed annuity may be a more suitable account.

In summary, indexed accounts are more aggressive than the traditional fixed annuities they evolved from. They are appropriate for consumers who might not be comfortable with direct exposure to the overall markets, but desire the possibility of above-average interest gains without the risk of market losses.

Our independent annuity agency offers fixed-indexed annuity accounts direct to consumers from several highly-rated and well-capitalized insurance companies. We will help you find the most suitable account to fit your investment needs.