Sometimes, it’s better to have a low guaranteed return than it is to take a big risk that might pay off (or might not). That’s the approach more people are taking amid tariffs and geopolitical tensions.
Fixed index annuities offer guaranteed returns for their investors. The baseline interest is different for each annuity, but fixed index annuities have the potential to deliver higher returns based on how the market performs. These financial products use a specific market index when calculating total returns.
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Just because an investment is getting more popular doesn’t mean you should put your capital into it. Fixed index annuities can work well for some people, but it’s best to know key details about these products while assessing your financial goals and risk tolerance:
— What is a fixed index annuity?
— How a fixed index annuity is administered.
— How fixed index annuities differ from other popular annuities.
— What’s fueling the rise of fixed index annuities?
— Who should consider a fixed index annuity?
— Downsides of fixed index annuities.
— Is a fixed index annuity right for you?
What Is a Fixed Index Annuity?
An annuity is a contract between you and an insurance company to cover specific goals, but the key to understanding this particular annuity product is the word “index.” You will recall that an index fund, unlike an actively managed mutual fund, tracks the performance of a market index instead of trying to outperform it.
Similarly, a fixed index annuity, also known as indexed annuity or equity-indexed annuity, offers payment or returns based on the performance of a market index (the S&P 500, for example). While some fixed index annuities track a single index, others track multiple indexes.
More importantly, a fixed index annuity is designed to protect annuitants from market downturns by guaranteeing that their capital will be preserved regardless of stock market performance. While the return is based on the performance of a market index, the money is not exposed to the stock market directly. Rather, annuitants receive an interest credit based on the index’s annual performance.
However, this protection comes at a cost: Your returns might be limited. That is, if the tracked market index returns 9%, your account might only grow by 7%, for example. In essence, while there is downside protection, there is also an upside limitation.
A fixed index annuity contract is a tax-deferred account, and you can set it up with a lump-sum deposit, multiple deposits or a qualified transfer from a retirement account.
How a Fixed Index Annuity Is Administered
There are various features that insurance companies use to provide both downside protection and upside limitation that are at the heart of indexed annuities. Below are popular upside limitation features:
Participation Rate
The participation rate is the portion of the index return that an annuitant will share. For example, if an insurance company offers an 80% participation rate and the annual return of the index is 10%, then the annuitant’s account will grow by only 8%.
The participation rate may also vary over the lifetime of the annuity contract.
Rate Cap
Some annuity providers will set a fixed rate of return that will be credited to the annuitant, irrespective of the actual return of the index. For example, if the rate is 10%, then that’s what you get even when the index returns 15% in a particular year.
Rate caps also change over the lifetime of the contract.
Fee
Alternatively, the annuity provider can set a fixed fee (say, 4%) and then deduct it from the return of the index. In this case, your return varies since the fee is fixed. However, the fees can also be changed.
For downside protection, the following features are used:
Adjusted Value
Most annuity providers will regularly adjust the minimum value of your account to reflect the returns you have earned.
Here, the minimum value is the lowest amount that can be in your account. In the beginning, it is the principal investment amount.
Minimum Return
The insurer may offer a guarantee to pay a particular interest rate regardless of the performance of the index. In this case, even when the index’s return is negative, you will earn the minimum return.
Loss Flooring
Some insurers set the highest amount of loss you can experience on the account to 0%. So, when the index’s return is negative, you won’t earn anything, but you also won’t lose anything.
Withdrawals
The first thing to note here is that a fixed index annuity is structured as a long-term contract. Consequently, it has a surrender period of five to seven years. If you choose to withdraw from it within this period, you will pay surrender charges or fees (the charges are lower the closer you get to the seventh year of the contract).
Second, instead of a lump sum withdrawal (liquidation), you can turn your fixed index annuity account into a guaranteed stream of income for a defined period, usually during retirement years. If you wait until after the surrender period, you can do this without paying any fee.
There is even a GLWB (guaranteed lifetime withdrawal benefit) rider that will pay you guaranteed income until death. This latter option is a good way to protect yourself against longevity risk — the risk of exhausting your retirement savings before death.
Third, note that a fixed index annuity is a tax-deferred account. You can fund your contract with either qualified or non-qualified dollars. Withdrawals will be taxed at the ordinary income tax rate. If you are making withdrawals prior to age 59 1/2, you will incur a 10% early withdrawal penalty.
How Fixed Index Annuities Differ From Other Popular Annuities
Fixed Index Annuities vs. Fixed Annuities
A fixed annuity locks in a particular interest rate for each year of the contract. Thus, you can know with certainty what you will earn every year. Fixed annuities can give this guarantee because they do not invest in the stock market, and so their returns are not subject to the vagaries of the market.
The downside to this is that in the long run, fixed annuities offer lower returns than fixed index annuities. Because they are based on changes to a benchmark index, fixed index annuities tend to offer a higher rate of return even after any of the upside limitation features have been applied.
Fixed Index Annuities vs. Variable Annuities
Variable annuities have no upside limit or downside protection, and their performance is based on the fluctuations of the stock market.
While this is beneficial during a bull market, it is dangerous during a bear market. And this is why many baby boomers who are now approaching retirement age have been making the transition to annuities providing downside protection even if that means lower returns.
What’s Fueling the Rise of Fixed Index Annuities?
When the stock market is firing on all cylinders, investors want to put their money into equities. Few assets can compete with the stock market during a bull run, especially when considering how easy it is to enter the stock market. You can buy individual stocks in a matter of seconds, and a wide range of exchange-traded funds, or ETFs, makes it easier for beginners to enter financial markets as well.
However, the same people who poured their money into the stock market may feel jittery during stock market corrections. International conflicts and the prospect of tariffs have captured plenty of headlines, resulting in rising anxieties for many investors.
When people feel anxious about investments, they often gravitate toward less risky assets that still generate positive returns. Aaron Brask, principal at Aaron Brask Capital, believes this is the main reason fixed index annuities have gained popularity. “There is no doubt that recent stock and bond market volatility has helped fuel annuity marketing and sales. In particular, fixed index annuities are generally structured so that they cannot lose money but still give investors exposure (though not 100%) to a stock market index,” Brask explains.
Higher interest rates have also played a role because elevated rates boost annuity returns. However, the Federal Reserve recently stated that it will cut interest rates by a half a percentage point in the second half of 2025, so some people may be rushing into annuities before rates inevitably drop.
The Fed’s signals on future rate cuts can also explain why people are rushing to fixed index annuities instead of variable index annuities. Fixed index annuities have guaranteed minimum interest rates combined with the potential for returns linked to market moves, while variable index annuities have rates that fluctuate based on the market. Any rate cut from the Fed will reduce how much you receive from a variable index annuity, while your cash flow will remain more stable with a fixed index annuity.
Who Should Consider a Fixed Index Annuity?
Every financial product has pros and cons. Fixed index annuities limit your upside but offer guaranteed returns, and that usually works best for people who are approaching retirement.
Tom Buckingham, chief growth officer at Nassau Financial Group, goes deeper into who should consider annuities: “FIAs offer strong benefits for those approaching and in retirement. They have attractive features for those looking to accumulate assets, guaranteed lifetime withdrawal benefits for those seeking secure income in retirement, and often additional benefits related to terminal illness. FIAs are a good option for many near and in retirement,” he states.
Thomas Alessi, president of ARIES Foundation for Financial Education, echoes those thoughts. He believes the volatility of index funds can rattle conservative investors and views fixed index annuities as a viable solution. “Conservative investors who need growth (would benefit the most from annuities). Generally, the swings of an index fund will be too much for a conservative investor to stomach and they will lose faith and pull out of a holding,” Alessi says. “By investing in a FIA, they have the opportunity to generate much higher returns than bonds or cash without the risk of losing any of their principal.”
Downsides of Fixed Index Annuities
Although fixed index annuities assure returns, they aren’t the best financial products for estate planning, says Jake Howell, founder of Howell Estate Planning. He adds that some of the downsides of annuities show up long after you have signed the contract. “While salesmen will tout tax-deferred growth, they fail to mention that the income, which must be withdrawn, will be taxed at ordinary income rates. Furthermore, the gains, unlike equities, do not receive a step-up in basis, meaning that your heirs will have to pay ordinary income tax on the money paid out by the contract, since it is not appreciation, it’s income from a contract,” Howell explains.
Howell also mentions that it’s uncertain what will happen to your annuity when you pass away. “Moreover, since it’s a contract, what happens to the money if you die can vary greatly depending on the specific terms of the contract. Sometimes the payments stop upon your death, and sometimes they continue for a set period of years. Each contract is different, and buyers should pay careful attention to the fine print.”
Fixed index annuities and similar low-risk financial products tend to get more attention when the stock market becomes more volatile and uncertain. Ironically, those are usually the best opportunities to buy stocks, and it ties into Warren Buffett’s advice that investors should be greedy when others are fearful.
Is a Fixed Index Annuity Right for You?
Fixed index annuities have characteristics of low-risk assets that may appeal to people who are about to retire. While the choice depends on your financial situation and risk tolerance, even the advocates for fixed index annuities believe you should only get into these products when you are approaching retirement.
People in their 20s should steer clear of annuities and focus more on high-growth assets like stocks and real estate. Younger investors have more time to endure market volatility and can forget about their portfolios for decades. People who are withdrawing from their nest eggs right now do not have the flexibility of forgetting about their portfolios for a bit.
Fixed index annuities offer a bunch of advantages that you won’t get with index funds. Buckingham highlighted some of them when explaining why he and his wife have fixed index annuities in their late 40s.
“FIAs offer tax-deferred growth and longevity protection via guaranteed lifetime withdrawal benefit riders, along with additional benefits that index funds do not,” he says.
Fixed index annuities may be the way to go if you have a large nest egg and want to get enough mileage out of your money. However, if you are into estate planning and maximizing how much wealth you can pass on to your heirs, index funds may be the better choice.
Howell reminds people why fixed index annuities can create unnecessary obstacles for estate planning and result in missed opportunities: “At their core, these financial products are the latest successful attempt by financial institutions that are seeking to profit from human fear. The products openly limit the buyer’s upside a little while secretly limiting the buyer’s upside a lot.”
However, some fixed index annuities offer beneficiaries the chance to spread their payments over several years to minimize their annual tax obligation. And some people can benefit greatly from the principal protection, tax-deferred status and potential lifetime income riders available in fixed index annuities. For others, these financial products are more trouble than they’re worth. Speaking with a financial advisor can help you decide if this wealth-building resource is right for you.
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Fixed Index Annuity: Why It’s Gaining Popularity Now originally appeared on usnews.com
Update 06/24/25: This story was previously published at an earlier date and has been updated with new information.
