A traditional fixed deferred annuity credits interest at a rate set by the insurer for a stated period. A fixed index annuity uses a contract formula tied to an index to calculate interest. Both are insurance contracts with limits on access to your money; neither is the same as owning an index fund or an FDIC-insured bank deposit.
The useful comparison starts with the job you want the money to do. Are you setting it aside for a future date, planning income, or keeping it available for unexpected expenses? The answer matters more than an advertised rate or an attractive illustration.
What is a fixed deferred annuity?
You pay an insurance company, and the contract describes how interest is credited while the money remains in the accumulation phase. The insurer sets a rate for a specified period. After that period, a renewal rate may apply, subject to the contract’s guarantees.
Some contracts guarantee the rate for several years. Check the rate period and surrender-charge period separately. Do not assume a quoted rate lasts as long as you own the contract. The NAIC’s annuity overview explains the main contract types.
How does a fixed index annuity credit interest?
A fixed index annuity, also called a fixed indexed annuity or FIA, is a type of fixed annuity. It uses an index change and a contract formula to calculate interest during accumulation. You are not buying the stocks in the index. A cap, participation rate or spread can limit the interest credited, and dividends are commonly excluded from the index calculation.
A cap limits the credit, a participation rate determines how much of an index gain enters the calculation, and a spread subtracts a stated percentage-point amount. The contract sets how these features work together.
For illustration only, suppose an index rises 10% for one crediting term and the contract applies a 50% participation rate, with no other adjustments. The calculated credit would be 5%. A cap or spread could change that result. These are invented numbers for explaining the calculation, not current product terms or a forecast.
Some crediting terms can change at renewal within contractual limits. Ask which terms are guaranteed, which can be changed and when interest is credited. The SEC’s indexed-annuity bulletin explains these mechanisms and why different indexed products must be distinguished.
Compare the actual contract terms
| Question | Traditional fixed deferred annuity | Fixed index annuity |
|---|---|---|
| How is interest determined? | Insurer-set rate for a stated period | Index-linked formula for a stated term |
| What happens after that period? | Check renewal rates and minimum guarantees | Check reset caps, participation rates, spreads and other terms |
| Do you own index investments? | No | No |
| Can early access reduce the amount received? | Yes; check charges and adjustments | Yes; check charges, adjustments and uncredited interest |
| Is lifetime income automatic? | Only as provided by the contract and choices made | Only as provided by the contract and choices made |
Ask for the disclosure and contract, not just a sales illustration. The NAIC’s buyer’s guide is a useful checklist for comparing these provisions.
Does a 0% floor mean you cannot lose money?
No. A 0% floor prevents a negative index-based interest credit for that term; it does not protect every measure of the contract’s value. Charges for optional features may reduce your account value. If you leave early, surrender charges and an applicable market value adjustment may affect what you receive. A market value adjustment can increase or decrease that amount. Inflation also affects what the money can buy.
Check the cash surrender value, not only the accumulation value shown in an illustration. Ask for amounts available if you withdraw in year one, year three and at the end of the surrender period. An insurer’s guarantees depend on its ability to meet its obligations.
Also confirm the product type. A registered index-linked annuity, or RILA, can expose you to index losses under its terms. It is not the same as the fixed index annuity described here. Investor.gov distinguishes these products.
How much can you take out, and when?
Ask about the surrender-charge schedule, any permitted withdrawals without a surrender charge, and exceptions. “Penalty-free” in an advertisement may refer only to the insurer’s surrender charge. It does not necessarily mean tax-free, free of other adjustments or unlimited access.
If someone proposes replacing an existing annuity, compare the old and new contracts’ benefits, fees, rates, withdrawal rules and risks. Leaving the old contract may trigger a surrender charge, and the new contract may start a new surrender period. Investor.gov’s exchanges guidance explains these tradeoffs.
Keep taxes and income promises separate
Tax-deferred growth is not tax-free income. Tax treatment depends on how the annuity is funded and how money comes out. Before age 59½, the taxable portion of an annuity distribution may be subject to an additional 10% federal tax unless an exception applies. Review IRS Publication 575 with a qualified tax professional before moving retirement money. An annuity inside a traditional IRA or another tax-deferred retirement plan does not add another layer of tax deferral, as Investor.gov explains.
If lifetime income is the goal, ask whether the proposal uses annuitization, an optional withdrawal benefit or another arrangement. Request the actual payment amount, when it can start, what happens after death and which choices can be changed. An income-benefit figure may not be money you can withdraw as a lump sum.
Is an annuity insured like a bank CD?
No. The FDIC lists annuities among products it does not insure, even when purchased through an insured bank. A contract guarantee from an insurance company is different from federal deposit insurance.
Common questions
Is a fixed index annuity an index fund?
No. It is an insurance contract with an index-based interest formula. You do not own the index’s stocks or receive its full return automatically.
Which type always pays more?
Neither. Compare the guaranteed terms, renewal rules, access limits and actual costs. An illustration of possible index credits is not a guaranteed return.
Can either type provide lifetime income?
Annuities can provide lifetime payments under specified options. Compare the actual income terms and tradeoffs; the words “fixed” or “indexed” alone do not describe your payment arrangement.
Before considering a purchase, keep money for emergencies and near-term spending separate from any amount you may commit for years. Our retirement policy review guide addresses the different job of existing life insurance.
Have a general question about a term in this guide? Contact ShieldWise. Please do not send account statements, tax documents or identity information through the general contact form. This guide does not quote or recommend a particular annuity or establish that a product is available through ShieldWise.
This article provides general education, not individual insurance, investment, legal or tax advice. Availability, underwriting and guarantees depend on the insurer, contract and state. Guarantees depend on the insurer’s claims-paying ability.