What are Equity-Index Annuities? How Do They Compare to Fixed Annuities?

Annuities are great tools to help you prepare for retirement and ensure that you don’t outlive your money. There are several types of annuities to choose from, depending on your personal finance goals and risk tolerance.

In this post, we focus on the differences between two popular choices for deferred annuity contracts: MYGA fixed annuities and equity-indexed annuities (also known as fixed-indexed annuities). Let’s start with the basics of deferred annuities.

What are Deferred Annuities?

There are lots of different types of annuities, but both MYGA fixed annuities and fixed-indexed annuities are types of deferred annuities.

Typically, deferred annuities work in two phases: the accumulation phase and the payout phase. Annuities have several benefits, but the top two are tax deferral during the accumulation phase and guaranteed income during the distribution phase.

In the accumulation phase, you pay in premium (either in a lump sum or a series of payments) and purchase your annuity. The annuity grows based on the interest rate it receives. MYGA fixed annuities and fixed-indexed annuities differ based on how they accumulate interest.

The accumulation phase officially ends on the annuity’s maturity date but that’s typically many years in the future. Most people transition from the accumulation phase to the payout phase much sooner than that. When you decide you would like to receive the money from your annuity, you have several choices.

You can take withdrawals or surrender your contract and receive a lump sum (but be careful of taking withdrawals during the surrender charge period) or you can annuitize your contract and begin receiving regular income payments. These payments can last for a number of years or for the rest of your life.

Now that it’s clear how deferred annuities work, let’s examine the nuances of MYGA fixed annuities and fixed-indexed annuities.

What Is a Fixed Annuity?

As the name suggests, fixed annuities offer a fixed rate of return, meaning your money earns a fixed minimum crediting rate for the entire annuity contract term. The insurance company that issues your fixed annuity will disclose the guaranteed minimum interest rate. Typically, they will declare a new interest rate annually, which may be higher, but never lower, than the minimum stated in your contract.

One type of fixed annuity that we’ve been referring to, called a MYGA, or multi-year guaranteed annuity, has a fixed minimum rate for a certain number of years. Once the initial term is over, the contract still maintains it’s fixed minimum guaranteed rate. For instance, you may buy a fixed annuity that has a MYGA term of 3 years.

The fixed annuity will guarantee you a minimum interest rate, say 1% until the contract matures. But the first three years may have a guaranteed rate of something much higher than the minimum (for a Canvas 3 year MYGA, the guaranteed rate is 2.60% for the first three years). After the three-year term is up, the annuity still has a minimum of 1% until maturity or higher as determined annually by the insurance company.

A MYGA fixed annuity has no variables; you’re guaranteed to earn at least the minimum rate of return for the entirety of your contract. That’s also why the timeframe is referred to as a "rate guarantee period." The most popular MYGA fixed annuity guarantee periods are 3, 5, and 7 years. If you leave your money in the annuity for the entirety of the rate guarantee period, you're guaranteed to be credited with the stated amount of interest.

Annuity contracts also come with a surrender charge period. If you withdraw money during this period, the company assesses what is known as surrender charges, or penalty fees for early withdrawals. Some companies allow you an annual penalty-free withdrawal amount or percentage.

What Is a Fixed-Indexed Annuity?

Just like a MYGA fixed annuity, a fixed-indexed annuity is a tax-deferred, long-term savings option. But unlike a MYGA that features a set interest rate, a fixed-indexed annuity’s crediting rate depends on market performance. A fixed-indexed annuity gives you more growth potential than a MYGA annuity, along with more risk.

As the name implies, returns are based on the performance of a chosen underlying index, such as the S&P 500 Index. Your annuity’s index value follows the overall performance of the market, but your money is never directly exposed to the volatility of the stock market. Unlike non-annuity stock market funds, fixed-indexed annuities have principal protection. This means that if there’s a market loss, you won’t lose any of your original principal.

This feature makes a fixed-indexed annuity safer than investing directly in the market. But this downside protection comes at a cost. You won’t receive the exact return of the market index. Instead, the annuity will limit both your potential gains and your losses. And if the index does not perform well, you could actually earn less money than you would with a MYGA fixed annuity since the fixed rate on most fixed-indexed annuities is 0%.

Benefits of a MYGA Fixed Annuity

People who want solid, guaranteed returns may want to choose a traditional MYGA fixed annuity, vs a fixed-indexed product. Why? In general, people who place money in MYGAs are doing so because they want certainty in their portfolio, or they have invested money elsewhere for this purpose and they seek the solid, guaranteed returns for the money they place in the MYGA.

This is the primary benefit of a MYGA -- a rate that is guaranteed by the issuing insurance company to be paid for the duration of the annuity contract. Tax deferral and guaranteed minimum crediting rates make a MYGA a great foundation upon which to build a comprehensive retirement portfolio.

Benefits of a Fixed-Indexed Annuity

One of the core benefits of a fixed-indexed annuity is that it has the potential to outperform a MYGA fixed annuity. Additionally, it can also earn more than certificates of deposit (CDs) and treasuries. Another big benefit of a fixed-indexed annuity is that you may be able to add a guaranteed lifetime withdrawal benefit (GLWB) rider onto the product.

So if you are willing to take a bit of risk to potentially out-earn MYGA fixed annuities and almost certainly out-earn traditional savings accounts, a fixed-indexed annuity may be a good choice.

Guaranteed Lifetime Withdrawal Benefits Explained

A guaranteed lifetime withdrawal benefit guarantees that you will receive lifetime income, generally at a higher rate than simply annuitizing your contract. If you choose the GLWB rider, the life insurance company guarantees you can withdraw a certain amount from the annuity annually, even when your balance is $0! The upside is that if you live a long life, the insurance company continues to pay the guaranteed amount annually for as long as you live.

The downside is that you must pay the insurer an annual fee to add the GLWB rider to your fixed-indexed product. This rider is best for people who are currently healthy and plan to continue a healthy lifestyle.

The Main Differences Between a MYGA and Fixed-Indexed Annuity

As we discussed, MYGA fixed annuities are issued by life insurance companies. The insurer invests premiums it receives from policyholders and in return credits interest to policyholders. MYGAs guarantee a minimum crediting rate. They may also declare a crediting rate that is higher than the minimum stated in the contract. The MYGA crediting rate is not based on index performance.

Fixed-indexed annuities are also issued by insurance companies. When you purchase this type of annuity you choose from a set of indexes. The performance of your chosen index dictates your crediting rate. Since these annuities still have a fixed minimum, you're protected from a negative crediting rate, but there are constraints on your earning potential as well.

Both MYGA and fixed-indexed annuities offer death benefits. In some cases, you must purchase a rider and in some cases, a death benefit provision is included in the base contract. Neither product is considered an investment product; they are insurance products.

When a Fixed-Indexed Annuity May Be the Right Choice

Fixed-indexed annuities can be a little complex and might not make sense for every buyer. They especially might not make sense for those who prefer the comfort and predictability of a MYGA fixed annuity.

But, for some a fixed-indexed annuity could be a great choice! You might want a fixed-indexed annuity if:

• You have money that you don’t currently need for living expenses and you desire to use that money to generate retirement income
• You’d like to earn better returns for retirement savings than you could earn with savings accounts or CDs than you would with a MYGA
• You don’t want to be exposed to stock market risk
• You want to maintain access to your money but also lock in guaranteed income payments for life if you don’t
• You see the peace of mind that comes with knowing exactly how much guaranteed income you can expect

If you are doing retirement planning and are considering a fixed-indexed annuity as part of your retirement plan, we suggest that you speak with a financial professional to better understand the products available. Annuities are great products for retirement. If you decide that the peace of mind of a MYGA fixed annuity is more your speed, check out the high rates offered on our Canvas Annuity products. Canvas is unique in many ways.

First, our rates are among the most competitive in the country. Second, we don’t pay commission to salespeople and pass the savings along to you in the form of great rates. Finally, if you choose, you can apply and buy online in minutes, or speak with one of our licensed non-commissioned agents.