Fixed vs. Fixed Index Annuity: What's the Difference?

Annuities are insurance contracts where you pay a premium upfront in exchange for future payments. They can add an income stream to your retirement plan. Two common types are fixed annuities, which provide a set rate of return, and fixed indexed annuities, which link returns to a market index for the chance of higher growth. A financial advisor can help you compare these options and decide whether an annuity fits into your overall retirement strategy.

What Is a Fixed Annuity?

A fixed annuity is a contract between a policyholder and an insurance company that guarantees a payout at some future date. You might get a lump sum, or a series of payments, depending on the terms of the contract. In exchange for these payments, you pay the annuity company a premium up front.

When you purchase an annuity, the money in the policy grows tax-deferred at a fixed rate. The exact rate you earn is spelled out in the contract. This phase is known as the accumulation phase, and it’s followed by the annuitization phase. At this point, you begin receiving payments from the annuity. The rest of the funds in the account continue to grow tax deferred.

The core benefits of fixed annuities include:

Predictable returns, with a guaranteed minimum interest rate
Tax-deferred investment growth
Steady stream of income for retirement or current needs
Premium protection

Fixed annuities also offer simplicity. Compared to other types of annuities, they’re more straightforward and easier to understand.

What Is a Fixed Indexed Annuity?

With a fixed indexed annuity, investors receive a minimum interest rate over a certain number of years, according to the contract’s terms.Returns are tied to the performance of an underlying stock market index like the S&P 500 or the Dow Jones Industrial Average (DJIA).

Your original investment is protected against market losses; any gains realized add to your returns. The terms of your contract determine how much interest accumulates and when that’s added to your annuity’s value.

Purchasing a fixed indexed annuity is one way to diversify a portfolio. It also gives you the opportunity to capitalize on a wide section of the market. Even though the benchmark does follow the index, you’re never truly exposed to the volatility of the stock market.

For example, let’s say you purchase an equity-indexed annuity. With this type of annuity, you may earn up to 80% of the returns of the S&P 500 over the past year. If stock prices dip, your annuity may pay a guaranteed percentage of between zero to 2%. It’s important to note, even if the stock market has a great year, you may only be able to earn as much as the capped maximum percentage, which is defined by the annuity contract.

Is a fixed annuity or fixed indexed annuity better?

Indexed annuities are more complex in nature, which could make them more challenging for some investors to understand.
While returns are guaranteed to a degree, your annuity’s value is in part tied to market performance.
You could earn better returns with a fixed indexed annuity, but you have to be comfortable with more risk.

Ultimately, your choice of annuity is personal. Your risk tolerance, goals and income needs can influence which type of annuity may be appropriate.

How Fixed Indexed Annuity Returns Are Calculated

Fixed indexed annuities credit interest based on three main contract terms:

Cap rate. The cap rate sets the maximum return you can earn in a given period, regardless of how well the index performs. For example, if the cap is 6% and the S&P 500 rises 10%, your credited return will be limited to 6%.
Participation rate. The participation rate determines how much of the index’s gain you receive. A 70% participation rate means that if the S&P 500 rises 10%, your annuity would be credited with 7%. Some contracts combine both a cap and a participation rate, which can further limit growth.
Spread. A spread or margin is another method insurers use to reduce credited returns. If your annuity has a 3% spread and the index rises 10%, you would be credited with 7%. If the index rises less than 3%, you would only receive the contract’s minimum guaranteed rate, often between 0% and 2%.

These features allow insurers to provide downside protection while limiting upside potential. Understanding how each factor works is essential to comparing fixed indexed annuities with other retirement income products.

Index Performance	Cap Applied	Participation Applied	Spread Applied	Credited Return	End Balance
+15%	Limited to 6%	6% (lower of cap or participation result)	N/A	6%	$106,000
+10%	Cap 6% vs. Participation 7% → Cap limits to 6%	6%	N/A	6%	$106,000
+5%	Under cap	3.5% (70% of 5%)	3.5% – 3% spread = 0.5%	0.5%	$100,500
–5%	Market down	0% floor applied	N/A	0%	$100,000

Key Differences

The biggest difference between fixed annuities and fixed indexed annuities is how the insurance company calculates interest. A fixed annuity offers a guaranteed interest rate for a specific amount of time. You can exchange your annuity for another without any tax consequences if you find the rate of return is too small or the surrender period expires. Then, a new surrender period would apply to the new contract.

A fixed indexed annuity offers a guaranteed interest rate as well as additional returns if the stock market performs well. However, the trade-off is that there is typically a larger surrender charge and the formula for calculating returns can often be extremely complex.

Again, the fixed indexed annuity will be the slightly riskier choice since no one can predict with absolutely certainty which way the market will move. However, owning this type of annuity could be a safer investment than trading individual stocks or more speculative investments like options, since you have some built-in market protection.

Which Annuity Is Right for You?

The type of annuity that you choose depends on your investment style, risk tolerance and reasons for including an annuity in your plan.

A fixed annuity, for example, may appeal to conservative investors who want limited risk while earning more than a money market or certificate deposit.

A fixed indexed annuity, on the other hand, may appeal to those who also want to limit risk but seek the possibility of higher returns tied to a market index.

Annuities are not liquid assets. Withdrawing funds before the term ends can trigger surrender fees, and if you are under 59½, you may also face a 10% penalty plus taxes on gains. For this reason, annuities may not be suitable if you expect to need cash soon.

FINRA also notes that an annuity is only as strong as the insurance company behind it. Before purchasing, research the provider and make sure you understand the benefits and drawbacks of the contract.

Bottom Line

Fixed annuities give a set return, while fixed indexed annuities offer potential for higher growth but come with some drawbacks.

Fixed annuities and fixed indexed annuities offer a guaranteed rate of return. However, fixed indexed annuities provide the potential to earn a higher rate of return because they’re tied to the performance of a stock market index. Even though both investments have relative principal protection, they still come with a few disadvantages. Looking at the bigger picture can help you decide whether annuities make sense for your situation.

Retirement Planning Tips

Consider talking to a financial advisor about whether a fixed or a fixed indexed annuities would make a good addition to your retirement portfolio. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Before you get an annuity you should know how much money you’ll need in retirement and whether you’re on pace to meet your goals. Get an estimate with SmartAsset’s free retirement calculator.