Printable checklist for your desk
Print this checklist and fill in the actual contract terms before you compare any two products.
Download the PDF (large print)The short version. A fixed indexed annuity earns interest that is linked to a market index, but you are not investing in the index. The insurer uses a formula to decide how much of the index change to credit. The floor means the credited interest is never below zero. The trade-off is that the formula limits how much upside you receive. [1, 2]
What you own
The NAIC says it directly: "When you buy an indexed annuity, you aren't investing directly in the market or the index." Your contract is an insurance contract with a formula for crediting interest. Index changes are generally calculated without dividends. [1, 3]
How interest is credited
| Method | How it measures the index | Source wording |
|---|---|---|
| Annual point-to-point | Compares the index on two dates one year apart. | NAIC [1] |
| Monthly averaging | Averages index values over the term and compares the average with the starting value. | NAIC [1] |
| Monthly point-to-point | Adds each month's change. Gains in a month are limited to the cap, but losses are not limited. | NAIC [1] |
Crediting periods are typically twelve months but can vary. Interest is determined at the end of each index term, and after it is credited it is usually locked in. [1, 3]
The three dials: cap, participation, spread
| Term | What it does | Example (FINRA) |
|---|---|---|
| Cap | The maximum interest you can earn in a term. | A 7% cap on a 12% index gain credits 7%. |
| Participation rate | The share of the index gain used to calculate interest. Often less than 100%. | 75% participation on a 10% gain credits 7.5%. |
| Spread (margin or asset fee) | A set percentage subtracted from the index gain. | A 3.5% spread on a 10% gain leaves 6.5%. |
Source: FINRA [4]. Examples are illustrations of how the terms work, not rates available today.
Different products use different combinations of these. A product with a high cap but a low participation rate is not necessarily better or worse than one with the opposite. Ask to see the credited rate in a year the index is up, flat, and down, using the actual contract terms.
The floor
If the index goes down over the period, zero interest is added. The SEC describes it this way: "The interest rate is guaranteed to never be less than zero, even if the market goes down." A zero year is still a year without growth, and fees such as rider charges can reduce your account value even when interest is zero. [2, 5]
Things that can change
- The company can change features for future periods. The SEC notes that the insurer may change some features periodically, such as the cap, and FINRA says some contracts let the issuer change fees, participation rates, and caps. Ask whether the contract has a minimum guaranteed cap or participation rate. [3, 4]
- Taking money out early can cost you interest. If you withdraw before an index term ends, the contract may not credit all of the index-linked interest for that term, and some contracts forfeit credited interest. [1, 3, 4]
The guaranteed minimum
State nonforfeiture laws set a minimum value for deferred annuities. The NAIC model law uses 87.5% of the premium, growing at a minimum rate that is the lesser of 3% and the five-year Treasury rate less 1.25%, but not less than 0.15%. FINRA has described indexed annuities as typically guaranteeing a minimum of between 1% and 3% on at least 87.5% of the premium. Your state's version may differ, so ask the seller for the contract's guaranteed minimum value in writing. [4, 6]
Income riders
Some fixed annuities, especially fixed indexed annuities, offer a rider that guarantees lifetime income, usually at an extra cost. The NAIC describes a guaranteed lifetime withdrawal benefit as one that guarantees income payments you cannot outlive. Riders have their own terms, so ask: [1]
- What figure is the income calculated from, and does it grow by a stated rate? Is that figure separate from the account value I could take as cash?
- What does the rider cost each year, and what is the charge applied to?
- When can I start income, and does the amount change by age?
- What happens to the rider if I take extra withdrawals?
- The SEC cautions that some guaranteed benefits depend on conditions, so you can pay for protection you never use. Which conditions apply? [2]
Questions to ask before you buy a fixed indexed annuity
- Which crediting method, and which cap, participation rate, or spread, applies in the first year? Which can change, and what is the guaranteed minimum?
- What is the guaranteed minimum value if I surrender, and when does it apply?
- What happens to credited interest if I withdraw mid-term?
- What are all the fees, including any rider charge?
- What are the surrender charges, and how much can I withdraw each year without one?
Frequently asked questions
Am I invested in the market with a fixed indexed annuity?
No. The NAIC says you are not investing directly in the market or the index. The insurer credits interest using a formula tied to an index.
What are cap, participation rate, and spread?
A cap is the maximum interest you can earn in a term. A participation rate is the share of the index gain used to calculate interest. A spread is a set percentage subtracted from the index gain.
Can the insurer change the cap or participation rate?
The SEC says the insurer may change some features periodically, and FINRA says some contracts allow the issuer to change fees, participation rates, and caps. Check your contract.
Sources and review notes
- NAIC: Buyer's Guide to Fixed Deferred Annuities (revised 2013; a rewrite is in draft)
- SEC Investor.gov: Annuities
- SEC Investor Bulletin: Indexed Annuities (updated July 31, 2020)
- FINRA: The complicated risks and rewards of indexed annuities (July 14, 2022)
- NAIC: Annuities (consumer overview)
- NAIC Model 805: Standard Nonforfeiture Law for Individual Deferred Annuities (2020 edition; check your state's version)
About this guide. This is general education, not tax, legal, or investment advice, and it is not a recommendation to buy or not buy any product. Nazim Lokhandwala is a licensed insurance professional who offers fixed and indexed annuity products. He does not offer variable annuities or registered index-linked annuities. This guide covers every type so you can compare, and an annuity is not the right choice for everyone. Annuity guarantees depend on the claims-paying ability of the issuing insurer. Product features, rates, and rules vary by company and by state, so read your contract and ask the seller to explain anything that is unclear.