Are Fixed Indexed Annuities the Best Option for Guaranteed Rates in Retirement?

If you’ve been reading about retirement investment options, you’ve probably come across annuities, particularly fixed annuities and fixed indexed annuities (also called equity indexed annuities, FIAs, or Fixed Index Annuities). These financial products have surged in popularity as people look for retirement income planning options that provide a steady stream of income.

In fact, LIMRA says fixed indexed annuity sales were up by 54% year over year in the third quarter of 2024. To explain why people are flocking to annuities, we’ve put together a list of the benefits, as well as the potential drawbacks.

Guaranteed Income and Guaranteed Rates: Benefits of Fixed Annuities vs. Fixed Indexed Annuities

An annuity is a contract between a buyer and an insurance company that allows the buyer to pay an upfront premium and receive a stream of payments in return. With a deferred annuity, the original premium payment has time to grow. With an immediate annuity, the buyer begins to receive payments shortly after signing the contract. Once annuitized, an annuity contract provides the buyer with a steady stream of payouts, making annuities a popular option for people who are looking for a regular income in retirement.

It’s important to note that there are different types of annuities. One critical difference hinges on whether it’s a fixed or variable annuity. A fixed annuity provides a guaranteed crediting rate and a guaranteed payment, while a variable annuity provides a variable crediting rate that may be higher or lower depending on how the underlying investment performs. Although variable annuities offer the potential for more income, they also carry considerably more risk – poor performance could result in smaller payments, meaning you won’t receive the income you were expecting. For retirees who are looking for a secure source of income during retirement, this risk may be a dealbreaker.

Although it’s a type of fixed annuity, a fixed indexed annuity provides something of a compromise between a regular fixed annuity and a variable annuity. With a fixed indexed annuity, your payment varies depending on the index that your annuity is “linked” to, which may be the Dow Jones Industrial Average, the S&P 500, or another index (as specified in the contract). However, your payments will have a minimum return rate that you will receive even if the market performs poorly. The difference between this and a variable annuity is that in a fixed indexed annuity your money is not actually invested in an index, it is merely the way your insurance company determines what crediting rate to use. If you select a fixed indexed annuity tied to the S&P 500, your crediting rate will be higher when the index performs better, but even if the index suffers a big loss, your crediting rate will never be less than 0%. This limits your risk, as your annuity won’t lose money when the index performs poorly. The tradeoff is there may also be a maximum rate that caps your returns even if the index performs better than expected.

The Benefits of Fixed Indexed Annuities in Retirement Income Planning

Data from LIMRA shows that investors are increasingly interested in fixed indexed annuities. What’s the appeal?

• Retirement income. One of the main appeals of any type of annuity is steady, reliable retirement income. Many people are worried about running out of money in retirement and want financial planning products that provide a stream of income during their golden years. Annuities (including fixed index annuities) are capable of providing retirement income – even lifetime income – which is a big part of why they’ve become so popular in recent years.
• Account value gains. If you purchase an annuity linked to an index that  performs well, you may see a decent return. If you purchase a fixed annuity with a guaranteed crediting rate, it’s easy to calculate the interest you will earn in a given year.
• A minimum guaranteed rate. Although the rate of return is somewhat variable in a fixed indexed annuity, the contract establishes a minimum guaranteed rate. It could be quite low – in some contracts, it may even be 0% – but at least you have some protection against poor market performance. In contrast, when you invest in the stock market directly, you risk losing your investment due to negative returns. The minimum guaranteed rate limits your exposure, which may provide peace of mind.
• Tax-deferred investment growth. Like other types of annuities, fixed indexed annuities offer tax-deferred growth. This means you do not typically have to pay income taxes on your earnings until you receive a payment. Tax deferral allows your money to grow faster than it would in a bank account or CD, since you don’t have to divert some of the funds to pay taxes on your earnings every year (meaning you’re still earning interest on the money you would have paid in taxes).

What About Drawbacks of Fixed Indexed Annuities?

Every investment option has drawbacks – even fixed indexed annuities. Before you decide to buy a fixed indexed annuity, make sure the advantages outweigh the disadvantages in your situation. If they don’t, another type of product (such as a regular fixed annuity) might be a better fit for you.

• Fees or charges. Since fees cut into the returns you receive, you need to keep them to a minimum. In general, fixed indexed annuities do not have fees, but there may be charges depending on any riders you select. Some rider examples would be a guaranteed lifetime withdrawal benefit rider (GLWB), a death benefit rider, or a nursing home rider. Read your contract carefully and ask about the charges.
• Complexity. Fixed indexed annuities can be more complex than regular fixed annuities. It’s important you understand your retirement income products to avoid unpleasant surprises. If fixed indexed annuities seem too complex, you may be more comfortable with a regular fixed annuity.
• Risk. Fixed indexed annuities limit your risk by protecting you from negative returns with a minimum return rate. This principal protection is important, but there is still a risk that your investment will not grow or will only grow a small amount if the market performs poorly. If you would be more comfortable with a flat guaranteed rate and guaranteed income, a  fixed annuity might be a better option for you.
• Surrender and early withdrawal costs. If you make annuity withdrawals from an annuity before you turn 59.5, you may face tax penalties under current IRS tax law. Additionally, your contract may have extra costs if you decide to make early withdrawals or surrender your annuity. Read your contract carefully and make sure you understand all the fees and surrender rules. These details are important and vary significantly between annuity providers.
• The annuity provider. To protect your retirement savings, it’s important to work with a company that is trustworthy and has good financial strength – this is true for all annuity types.

Is a Fixed Indexed Annuity Right for You?

When it comes to retirement income planning, everyone’s risk tolerance varies. If you are happy to take on some risk and would like the potential for a higher  yield, a fixed indexed annuity may be a good fit for you.

However, if you are more interested in a simple, guaranteed rate for more predictable, reliable retirement income planning, you may be more interested in a regular fixed annuity.

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