Fixed indexed annuities
A fixed indexed annuity credits interest based partly on how a market index performs, within limits the insurer sets. You give up part of the index gains to avoid index losses. Rider fees and early-withdrawal charges can still reduce your value. This page explains exactly how much you give up, and how.
The short version
A fixed indexed annuity (FIA) is an insurance contract. You pay the insurer a premium. The insurer credits interest using a formula tied to a market index, such as a well-known stock index.
Your money is not placed in the market. The index is only a yardstick for calculating interest. When the index goes down over a crediting period, you are typically credited zero for that period, not a loss. When it goes up, you get part of the increase, not all of it.
That is the whole trade. Everything else on this page is the detail of how much of the increase you keep, how long your money is committed and what it costs to leave early.
The limits on your interest
Each year, or each crediting period, the insurer measures the index and applies one or more limits. A contract usually offers several options, called crediting strategies. Each strategy uses one of these:
- Cap
- The most interest you can be credited for the period. If the index rises more than the cap, you get the cap.
- Participation rate
- The share of the index increase you are credited. At a participation rate below 100%, you get only that share of the gain.
- Spread
- Also called a margin. A percentage subtracted from the index increase before interest is credited. If the index rises less than the spread, you get zero.
- Floor
- The least you can be credited for the period, usually zero. This is the part that protects you from index losses.
A hypothetical example
These numbers are invented to show the arithmetic. They are not rates from any insurer or contract, and they do not predict what any index or annuity will do.
| Strategy (hypothetical) | Index rises 10% | Index rises 2% | Index falls 10% |
|---|---|---|---|
| 5% cap | 5% credited | 2% credited | 0% credited |
| 50% participation rate | 5% credited | 1% credited | 0% credited |
| 3% spread | 7% credited | 0% credited | 0% credited |
Things the example leaves out
- Limits can change. The insurer can usually reset caps, participation rates and spreads at the start of each new crediting period, within minimums printed in the contract. Ask what those minimums are. The first-year limit tells you little about later years.
- Many indexes leave out dividends. Index changes are often measured on price alone, so the index number can rise less than the total return of the stocks in it.
- Some indexes are built by banks or insurers and are designed to limit swings. Their history may be partly back-tested, meaning calculated after the fact. Ask how long the index has existed in real time.
- Optional riders cost money. An income rider fee is taken from your value every year, including years when you were credited zero. See Income for life.
Surrender periods and market value adjustments
A fixed indexed annuity is a long-term contract. Most have a surrender period, a number of years during which taking out more than the allowed amount triggers a surrender charge. The charge is a percentage of what you take out above the free amount. It usually shrinks each year until it reaches zero.
Many contracts let you take a portion out each year without a charge. The contract states the amount. Taking out more than that, or cancelling the contract during the surrender period, costs you the charge.
Many FIAs also have a market value adjustment (MVA). It applies to withdrawals above the free amount during the surrender period. If interest rates have risen since you bought, the MVA usually reduces what you get. If rates have fallen, it can increase it. It is not a penalty in name, but it can work like one.
Put together: leaving early can cost real money, even if the index went up. Assume you will keep the contract for the whole surrender period. If you are not confident of that, an FIA is probably not for you.
Who it can fit, and who it doesn't
Can fit
- You want no index losses on a portion of your savings and accept limited gains for that.
- You can leave this money alone for the entire surrender period.
- You have an emergency fund and other money you can reach.
- You are comfortable that interest can be zero in some years.
- You may want lifetime income later and understand what an income rider costs.
Often doesn't fit
- You may need the money within the surrender period.
- You want the full growth of the market and can live with its losses.
- You want a simple, predictable rate. A fixed annuity may be clearer.
- You would be putting in most of what you have.
- Someone showed you a projection of high returns and that is why you are interested.
What to watch for
- Illustrations that look too good. An illustration is a hypothetical. It is not a promise. Ask to see the guaranteed column next to any other column.
- A first-year number that drives the decision. Ask about the minimum cap or participation rate the contract allows, not just the starting one.
- Back-tested index history. Ask which years are real and which were calculated afterward.
- Long surrender periods. Ask for the full schedule, year by year.
- Replacing an annuity you already own. A new contract usually starts a new surrender period. If an agent suggests a replacement, ask for the comparison in writing.
Questions to ask any agent
- What are the cap, participation rate or spread for each strategy, and what are the contract minimums?
- How often can the insurer change them?
- How long is the surrender period, and what is the charge in each year?
- Is there a market value adjustment? Show me an example of how it works.
- What fees come out of my value, and for what?
- Does the index include dividends? How long has it existed in real time?
- What do you earn if I buy this?
- What is the insurer's financial strength rating, stated in full, and as of what date?
We put the answers to every one of these in writing before you decide.
Questions are free.
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