6 Fixed Indexed Annuity Myths That Could Affect Your Retirement Decisions

Quick Answer

Fixed indexed annuities, or FIAs, are insurance contracts designed to provide principal protection from direct stock-market losses while offering interest-crediting potential tied in part to the performance of an external market index. You don’t directly invest in the index, and your credited interest won’t necessarily equal the index’s return. FIAs can also provide options for guaranteed lifetime income, but guarantees, liquidity, fees, withdrawal provisions and income features vary substantially by contract. NAIC Content

That’s why asking whether fixed indexed annuities are simply “good” or “bad” isn’t particularly useful. A better question is: What retirement problem are you trying to solve—and does a particular annuity contract solve it appropriately?

Why Are Fixed Indexed Annuities So Misunderstood?

Few retirement products generate opinions as quickly as annuities. Search online and you’ll find people who seem to believe everyone should own one. Keep searching and you’ll find people who seem to believe nobody should. Neither extreme is particularly helpful. An annuity is a contract. And contracts don’t have agendas. People do.

A fixed indexed annuity should therefore be evaluated based on what the contract actually does, what it costs, what it guarantees, what it doesn’t guarantee, and whether those features address a particular retirement need. The NAIC describes an annuity as an insurance contract sold by a life insurance company. Depending on the type of annuity and contract provisions, annuities can accumulate value and provide retirement income, including income that can last for life. NAIC Content A fixed indexed annuity is one particular type.

It combines characteristics that are sometimes misunderstood:

Protection: Contract value is generally protected from direct losses caused by a decline in the referenced market index, subject to the specific contract’s provisions.

Growth potential: Interest may be credited based partly on the performance of an external index.

Tax deferral: For nonqualified money, earnings generally aren’t taxed until distributed.

Income: Depending on the contract, lifetime income can be established through annuitization or certain income-benefit provisions.

Those characteristics don’t make an FIA appropriate for everyone. But they do make it worth understanding what the product actually does before accepting some of the most common claims about it. Let’s examine six of them.

Myth #1: “Fixed Indexed Annuities Are Full of Hidden Fees”

This claim needs context. Some fixed indexed annuities have no explicit annual contract fee for their basic accumulation features. Others offer optional riders or crediting strategies that carry charges. What matters is understanding the specific contract.

What Costs Should You Look For?

Depending on the annuity, potential costs or limitations can include:

• surrender or withdrawal charges,
• optional income-rider charges,
• enhanced death-benefit rider charges,
• strategy fees,
• market value adjustments,
• spreads,
• participation rates,
• and caps on credited interest.

Not everything on that list is technically a “fee.” For example, a cap or participation rate is generally part of the formula used to determine how much index-linked interest is credited rather than a fee deducted from the account. But it can still affect the return you receive. Suppose an index rises 10%. That doesn’t necessarily mean your FIA receives 10%. A contract might apply a cap, participation rate, spread or another crediting formula.

The SEC’s indexed-annuity educational guidance explains that participation rates, caps and other contract features can result in credited interest being lower than the change in the referenced index. Securities and Exchange Commission That’s not inherently good or bad. It’s part of the tradeoff you’re accepting for the contract’s guarantees and protection features.

The Better Question

Don’t simply ask: “Does this annuity have fees?” Ask: “Show me every charge, limitation, cap, participation rate, spread, surrender provision and rider cost—and explain what I receive in exchange.” If someone can’t clearly answer that question, don’t buy the contract until you understand it.

Myth #2: “A Fixed Indexed Annuity Is Just Another Stock-Market Investment”

This is one of the biggest misunderstandings about FIAs. You aren’t directly investing your annuity premium in the S&P 500 or another market index. An index is used as part of a formula for determining potential interest credits. That’s very different from owning stocks or an index fund.

What Happens When the Market Goes Up?

Suppose a particular index rises during the contract’s crediting period. Depending on the crediting strategy, your FIA may receive positive interest credits. But the amount credited can be affected by the contract’s:

• cap,
• participation rate,
• spread,
• index methodology,
• crediting period,
• and other terms.

Also, commonly referenced market-index calculations for annuity crediting may exclude dividends, so comparing an FIA’s credited interest directly with the total return of an equity investment can be misleading. The SEC specifically warns consumers to understand how indexed-annuity interest is calculated. Securities and Exchange Commission

What Happens When the Market Goes Down?

This is where a traditional fixed indexed annuity can serve a very different purpose from direct market investing. Under many traditional FIA crediting strategies, a negative index result doesn’t create a corresponding negative interest credit due solely to that market decline. For example, if the index falls 20%, the applicable index-crediting result might be 0% rather than -20%, depending on the contract. That doesn’t mean you can never lose money in an annuity.

Early surrender charges, withdrawals exceeding permitted amounts, applicable adjustments, rider or strategy charges, and other contract provisions can reduce value. Guarantees also depend upon the financial strength and claims-paying ability of the issuing insurer. Securities and Exchange Commission This distinction matters: Protected from direct market losses does not mean protected from every possible way a contract’s value can decline.

Myth #3: “Fixed Indexed Annuities Aren’t Tax Efficient”

For nonqualified money, fixed indexed annuities generally provide tax-deferred growth. That means interest credited inside the contract generally isn’t taxed annually while it remains in the annuity. Taxes are generally due when taxable amounts are distributed. Tax deferral can allow money that otherwise might have been paid in current taxes to remain inside the contract and potentially continue earning interest. But there’s an important qualification.

An IRA Is Already Tax-Deferred

Suppose you use IRA or 401(k) money to purchase an annuity. The retirement account already provides tax deferral. Putting that money into an annuity doesn’t give it an additional layer of tax deferral. Athene itself makes this qualification in its discussion of FIA tax treatment, and it’s an important one for consumers to understand. Athene So why might someone put IRA money into an annuity? Potential reasons could involve other contract features, such as:

• principal protection,
• lifetime income,
• death-benefit provisions,
• or other guarantees.

But additional tax deferral isn’t the reason, because qualified retirement money already has it.

Tax-Deferred Doesn’t Mean Tax-Free

This distinction also matters. Annuity earnings aren’t automatically tax-free. Tax treatment depends on whether money is qualified or nonqualified, how distributions are taken, the owner’s circumstances and applicable tax law. The right description is tax-deferred, not “tax-free.”

Myth #4: “My Money Is Completely Locked Up”

Fixed indexed annuities are designed primarily as long-term retirement vehicles. So yes, liquidity can be more limited than a bank account or brokerage account. But “completely locked up” usually doesn’t accurately describe how many FIA contracts work.

Many Contracts Provide Some Penalty-Free Access

Depending on the contract, an owner may be permitted to withdraw a specified amount or percentage each year without incurring a surrender charge. Some contracts may also provide additional liquidity provisions for qualifying circumstances. But those provisions vary. And taking more than the contract permits during its surrender period can trigger a surrender charge or other adjustment. That’s why the surrender schedule deserves attention before purchasing an annuity.

Match the Contract to the Money

Suppose you have $500,000 of retirement assets and $100,000 may be needed over the next two years for:

• a home purchase,
• major renovations,
• healthcare,
• helping family,
• or another known expense.

Putting money you know you’ll need soon into a long-term contract with withdrawal restrictions may not make sense. This isn’t necessarily a flaw in the annuity. It’s a mismatch between the product and the purpose of the money. A sound retirement plan generally maintains appropriate liquidity outside long-term insurance contracts. Money needed soon shouldn’t be treated the same way as money designed to fund income 10, 20 or 30 years into retirement.

Myth #5: “A Fixed Indexed Annuity Can’t Help With Inflation”

This claim also needs nuance. An FIA doesn’t magically eliminate inflation. And nobody should promise that an annuity will automatically keep pace with inflation throughout retirement. But certain FIA designs can provide growth potential and income features that may help address rising income needs.

Inflation Is Really a Purchasing-Power Problem

Suppose your retirement lifestyle requires $5,000 per month today. At a hypothetical 3% annual inflation rate, maintaining equivalent purchasing power would require approximately: $6,720 per month in 10 years and roughly: $9,030 per month in 20 years. That’s why a retirement paycheck that never changes can still become a smaller paycheck in real terms.

Can Annuity Income Increase?

Depending on the contract and optional benefits selected, some annuities provide opportunities for income to increase under specified conditions. Other contracts may provide a level guaranteed income stream. Still others may emphasize accumulation and protection rather than increasing income. The details matter. Instead of asking: “Does an annuity beat inflation?” ask: “How does my entire retirement-income plan address the possibility that my expenses rise over the next 20 or 30 years?” An FIA may be one component of that answer.

It shouldn’t automatically be assumed to be the entire answer.

Myth #6: “If I Have an Annuity, I Don’t Need Life Insurance”

Annuities and life insurance can both be issued by life insurance companies. That doesn’t mean they solve the same problem.

Life Insurance Primarily Addresses What Happens When You Die

Life insurance is generally designed to provide a death benefit to beneficiaries. That can help address needs such as:

• replacing income,
• supporting a surviving spouse,
• paying debts,
• leaving a legacy,
• providing liquidity,
• or meeting other estate and family objectives.

Certain permanent life insurance policies can also accumulate cash value, but the death benefit remains a central insurance purpose.

Annuities Primarily Address What Happens While You’re Alive

One of the fundamental retirement risks an annuity can address is: What if I live a very long time? Annuities can be structured to provide income for life, depending upon the contract and income option selected. That’s why life insurance and annuities shouldn’t automatically be viewed as competing products. One may help protect against the financial consequences of dying too soon. The other can help address the financial consequences of living longer than expected. Some households may need one. Some may need both.

Some may need neither. Again, start with the problem—not the product.

The Bigger Misunderstanding: “All Annuities Are Basically the Same”

This may be the most important myth of all. The word annuity describes an entire category of insurance contracts. It doesn’t describe one single product. There are:

• immediate annuities,
• traditional fixed annuities,
• multi-year guaranteed annuities,
• fixed indexed annuities,
• variable annuities,
• and registered index-linked annuities.

And within those categories are contracts with very different:

• surrender periods,
• income benefits,
• crediting strategies,
• caps,
• participation rates,
• liquidity provisions,
• death benefits,
• riders,
• and guarantees.

This is why statements such as: “Annuities are great.” or “Annuities are terrible.” aren’t particularly informative. Which annuity? For whom? For what purpose? Under what contract terms? Those are the questions that matter.

What Problem Can a Fixed Indexed Annuity Potentially Solve?

Instead of starting with the product, start with your retirement concerns.

“I Don’t Want This Portion of My Retirement Money Exposed to Direct Market Losses”

An FIA may deserve consideration for money where protection from direct market downturns is a priority, provided you understand the contract’s limitations.

“I Want Some Growth Potential Without Directly Investing This Money in the Market”

An FIA can provide index-linked interest-crediting potential without direct ownership of the securities in the referenced index. But remember: you aren’t receiving the index itself, and credited interest can be limited by contract terms.

“I’m Worried About Running Out of Income”

Certain annuity structures can provide contractually guaranteed lifetime income. That’s one of the characteristics that makes annuities fundamentally different from simply withdrawing money from an investment account. The NAIC specifically recognizes lifetime income as an important retirement-income function of annuities. NAIC Content

“I Want More Predictability in Retirement”

This may be where an FIA fits best for some households. Not necessarily as the place for every retirement dollar. But potentially as one part of a retirement plan where protection and predictable income have specific jobs to do.

The Question Isn’t “Annuity or No Annuity?”

Imagine you have $1 million saved for retirement. The question doesn’t necessarily need to be: “Should I put my $1 million into an annuity?” A more useful question might be: “How much of my retirement income do I want dependent upon the market—and how much do I want contractually guaranteed?” Suppose Social Security and a pension cover $4,000 of your monthly expenses. But you need $6,000 to cover essential living costs. That leaves a $2,000 monthly income gap. Now the conversation becomes much more specific.

How will you fill that $2,000? Will it come from portfolio withdrawals? Cash? An annuity? Another income source? A combination? And what happens to that income if:

• markets decline,
• you live to 95,
• your spouse outlives you,
• inflation raises expenses,
• or you experience an extended retirement?

Those are retirement-planning questions. The annuity is simply one potential tool for answering them.

How to Evaluate a Fixed Indexed Annuity Before Buying One

If you’re considering an FIA, don’t stop at the illustration. Ask questions.

What is guaranteed?

Separate contractual guarantees from hypothetical values.

What isn’t guaranteed?

Understand which interest rates, caps, participation rates or other crediting factors can change.

How is interest calculated?

Ask for an explanation you can understand.

How long is the surrender period?

Know exactly when and how surrender charges apply.

How much can I access without a surrender charge?

Understand annual withdrawal provisions.

Are there rider or strategy charges?

Know what you’re paying and what the feature provides.

How does lifetime income work?

Understand whether income comes through annuitization, a withdrawal benefit, or another contractual mechanism.

Can the income increase?

If increasing retirement income matters to you, understand exactly how—and under what conditions—it can happen.

What happens when I die?

Review beneficiary and death-benefit provisions.

What is the insurer’s financial strength?

Annuity guarantees aren’t backed by the stock market or federal government. They depend on the issuing insurance company’s financial strength and claims-paying ability. And perhaps most importantly:

Why is this particular annuity being recommended to me?

The answer should connect directly to a problem in your retirement plan.

Key Takeaways

• Fixed indexed annuities are insurance contracts, not direct stock-market investments.
• Index-linked doesn’t mean you receive the index’s actual return. Caps, participation rates, spreads and other contract terms can affect credited interest.
• Principal protection from direct market downturns isn’t the same as saying you can never lose money. Withdrawals, surrender charges, adjustments and applicable fees can matter.
• Tax-deferred doesn’t mean tax-free. And qualified retirement accounts already provide tax deferral.
• FIAs generally have liquidity provisions, but they’re designed for long-term money and can impose surrender charges for excess withdrawals.
• Some annuity designs can help address rising retirement-income needs, but no FIA should automatically be assumed to keep pace with inflation.
• Life insurance and annuities solve different problems. One primarily protects beneficiaries after death; the other can help provide income while you’re living.
• Different annuity contracts can work very differently.
• Start with the retirement problem you’re trying to solve—not with the product someone wants to sell you.

Frequently Asked Questions About Fixed Indexed Annuities

Can I lose money in a fixed indexed annuity?

Traditional FIA designs generally protect contract value from direct losses caused solely by declines in the referenced market index. However, that doesn’t mean loss is impossible. Surrender charges, excess withdrawals, contract adjustments, rider or strategy charges and other provisions can reduce value. The SEC also notes that indexed-annuity terms vary, so consumers should review the actual contract carefully. Securities and Exchange Commission

Is a fixed indexed annuity invested in the stock market?

No. A fixed indexed annuity is an insurance contract, and the owner isn’t directly investing in the stocks that make up the referenced index. Changes in an external index are used as part of the formula for determining potential interest credits. The credited amount can be affected by caps, participation rates, spreads and other contract terms. Securities and Exchange Commission

Are fixed indexed annuity returns capped?

Some crediting strategies use caps, while others may use participation rates, spreads or different formulas. A cap limits the amount of index-linked interest that can be credited for the applicable period. Contract terms can differ considerably, so review how each available strategy works rather than assuming every FIA credits interest the same way.

Are fixed indexed annuities tax-free?

No. Tax-deferred and tax-free aren’t the same thing. Earnings in a nonqualified annuity generally grow tax-deferred until distributed. Taxation depends upon how the annuity is funded and how money is ultimately distributed. An annuity funded with qualified retirement money such as IRA assets doesn’t create an additional tax-deferral benefit.

Can a fixed indexed annuity provide guaranteed lifetime income?

Depending on the contract, lifetime income may be available through annuitization or an income-benefit feature. Specific guarantees, costs, withdrawal rules and income provisions vary. All guarantees depend on the financial strength and claims-paying ability of the issuing insurer.

Should I put all my retirement savings into an annuity?

Generally, retirement planning should consider multiple needs, including liquidity, growth, income, emergencies, taxes, healthcare and legacy objectives. An annuity may be appropriate for a portion of someone’s assets when its contractual benefits address a specific need, but whether—and how much—belongs in an annuity requires an individual analysis.

Don’t Ask Whether Annuities Are Good or Bad

That’s the wrong question. Ask instead: What am I trying to accomplish? Do you need growth? Protection? Liquidity? Lifetime income? Legacy? Flexibility? A combination? Then determine which financial tools best accomplish those jobs. A fixed indexed annuity isn’t automatically the answer. But it shouldn’t automatically be dismissed because of something you’ve heard about “annuities,” either. Understand the contract. Understand the tradeoffs. Understand the guarantees. And most importantly, understand why you’re considering it.

You can use SafeMoney.com’s free retirement calculators to begin estimating how much income your retirement savings may need to provide. Calculator results are educational estimates based on the assumptions entered and aren’t predictions, guarantees or individualized recommendations. If you’d like help determining whether guaranteed income or principal protection has a role in your retirement strategy, you can also connect with an independent financial professional through SafeMoney.com’s advisor network. Because when it comes to annuities—or any retirement strategy—the most important question isn’t:

“What product should I buy?” It’s: “What problem am I trying to solve?”

Important Disclosure

This article is for general educational purposes only and isn’t individualized financial, investment, insurance, legal or tax advice. Fixed indexed annuities are insurance contracts and aren’t direct investments in a stock-market index. Interest-crediting methods, caps, participation rates, spreads, riders, fees, surrender periods, liquidity provisions and other features vary by contract and may change subject to contract terms. Withdrawals may be subject to surrender charges, income taxes and, where applicable, federal tax penalties. Annuities funded with qualified retirement assets don’t provide additional tax deferral beyond that already provided by the qualified account. Guarantees, including principal protection and guaranteed lifetime-income benefits, are subject to contract terms and the financial strength and claims-paying ability of the issuing insurance company. Product availability varies. Review the applicable contract and disclosure documents before purchasing an annuity.