What Are Fixed Indexed Annuities?

by Kimberleo ; Updated July 27, 2017

In the most simplistic terms, a fixed indexed annuity is a hybrid of both a fixed annuity and a variable annuity. Unfortunately, relying on simplistic terms leads to confusion over what is actually a very complex deferred annuity structure. Understanding the various ways these financial products work helps consumers prevent investment mistakes.

Similar to a Variable

When listening to a sales pitch for a fixed indexed annuity, consumers will often hear something to the effect of, "When the market goes up, you get higher returns." This sounds great, especially since there are protections when the market goes down. But how the upside potential is calculated is different from contract to contract. First, know what index the annuity is tied to; the S&P 500, NASDAQ and Dow Jones Industrial Average are common indexes. Don't assume that watching the index return will give you the performance of your annuity. The annuity contract spells out what type of indexing method is used. Some indexing methods use the calendar year; others choose the high-water mark for the year; and yet others use the contract anniversary date. All these will alter how your annuity performs, as will other caps and costs.

Caps on Growth

If your indexed annuity follows the S&P 500, and that index grows 30 percent in one year, don't expect to see anywhere near that type of return in the annuity. Insurance companies must protect themselves for extended down markets and thus limit the amount you can earn in any one year on the annuity, regardless of how well the market does. This is accomplished by two limiting factors: the participation rate and the cap rate. The participation rate states that you can only receive a percentage of the growth of the index; if the S&P 500 is up 30 percent but your participation rate is 80 percent, 24 percent is the allowed participation rate return. However, there may also be a cap rate of 10 percent, meaning that even though your participation rate is 24, you can not exceed 10 percent per year in returns.

Similar to a Fixed

Fixed annuities are promoted for having no downside when the market goes down, protecting principal assets and thus being worth the costs and caps. The fixed part of the fixed indexed annuity refers to a minimum guarantee on your money. The participation rate and caps exist to guarantee a minimum rate of return when the index is down. Keep in mind, the indexing method may affect whether or not you qualify in any one down year for the minimum guarantee, which is often a nominal rate of return ranging from 1 to 3 percent.


While the fixed indexed annuity is a supplemental retirement structure allowing tax-deferred growth with no penalties on distributions after age 59 1/2, there are many other time-constraining issues. Many indexed annuities are more than 10 years in duration to give insurance companies time to earn profit margins in down markets. The surrender charges are high to discourage early distribution. Essentially, to ensure its own profitability, the insurance company is containing investors. There is no regulation to participation rates, cap rates, surrender periods or charges, or allowable penalty-free distributions. Consumers can read through historical returns about 10 indexed annuities, all based on the same index, and be confounded with the differences in investment returns over the same time frame.

About the Author

In 2001, Kay Miranda had her second screenplay purchased, then started writing a weekly column in "The Messenger," with work appearing in "Xquisite" and "Valley Scene Magazine." Miranda earned a Bachelor of Arts in bio-psychology from the University of Colorado. Fortunate to play collegiate tennis, Miranda has extensive travel and coaching experience.