Which is Better:
A Fixed Annuity or an Indexed Annuity
Every fixed indexed annuity is first a fixed annuity, but the similarities don’t stop there. Both contracts have more in common than they have differences. Which is better?
Every fixed indexed annuity is first a fixed annuity, but the similarities don’t stop there. Both contracts have more in common than they have differences.
Which is better? That depends on risk tolerance and what you want to accomplish.
Before we look at how the contracts differ, let’s explore how each is similar.
Similarities Between Fixed annuities and Index Annuities
Both types of annuity are considered fixed because the principal balance is guaranteed by the insurance company to not lose money. Fixed annuities existed first and fixed indexed annuities were just a variation of the original product that came to market in the mid-90s. The main difference is how interest is credited to the account but we’ll get to that later. Aside from both being fixed contracts, there are several other similarities.
| Fixed Annuities | Index Annuities | |
| Bonuses | Yes | Yes |
| Fees | No fees | No fees |
| Lifetime Income Riders | Guaranteed | Guaranteed |
| Long-Term Care Enhancements | Multiple of the initial premium | Income Enhancement |
Bonuses
Both fixed and fixed indexed annuities have premium bonuses added to the account value when issued.
It’s not just free money, of course, because in each case it leads to lower rates than could be found in contracts without the bonus. All in all, it should work out the same but it takes acute analysis to determine which might be the best option.
Some bonuses come only as an enhancement to lifetime income as explained below. In this case, it does not increase the cash value of the contract and many agents fail to explain this properly.
Both types of bonuses are available but the income enhancement variety is only seen with fixed indexed annuities.
Fees
Because both contracts are fixed, neither of them in basic form has any fees whatsoever.
Fixed insurance products work on a spread, rather than fees. The insurance company invests your money at one rate and pays you a lower rate. The difference between the two is the spread which represents the insurance company’s revenue. The resulting contract is net of fees.
Guaranteed Lifetime Income Riders
All annuity contracts contain provisions for “annuitizing” the account value. That’s what makes them annuities. I’m talking about something different.
Annuitizing the account value means exchanging the cash value of the contract for a series of set payments or lifetime income.
If you instead add a guaranteed lifetime income rider, the principal stays within your control and you’ll get a secondary guarantee of a lifetime income guarantee. Under this rider, you pay a fee but the account continues to grow by a fixed or indexed rate, and income payments are deducted from the account value.
Over time, the cash value will drop to zero and the additional rider guarantees that payments will continue as long as you live. Many people like this option because they don’t feel so much like they are giving up money to get the income guarantee. Only a small handful of fixed annuities have this option and most fixed indexed annuities have it.
Either way, I consider this to be something the two contracts have in common.
Long-Term Care Enhancements
Most often, but not always this is an enhancement of the lifetime income riders. The way this option works is mostly a difference between the two contracts but each does have it. True long-term care contracts work on a fixed annuity platform.
I say ‘true’ because distributions for care expenses are qualified, meaning tax-free. Long-term care enhancements for fixed annuities typically offer a 2X to 3X multiple of the initial premium that is available when the annuitant qualifies for long-term care under the contract’s definition.
With a fixed indexed annuity, long-term care enhancements simply increase the guaranteed income payout for a period of time as long as conditions stated in the contract are met.
Where a fixed annuity might offer tax-free payments for long-term care, an income enhancement in a fixed indexed annuity would be seen as additional taxable income. While the additional insurance available in each of these contracts can differ greatly, both types carry provisions for the benefit.
Differences Between Fixed annuities and Index Annuities
| Fixed Annuities | Index Annuities | |
| Credited Interest | Guaranteed Fixed interest rate | Indexed to market with 0% Floor |
| Free Withdrawals | Interest only or up to10% | 5% to 10% |
| Renewal After Surrender Term | Annually Renewable or 30-day Window | Annually Renewable |
Credited Interest
The biggest difference between fixed and fixed indexed annuities is how interest is credited to the account. Each is explained below.
Fixed annuities credit a guaranteed fixed interest rate for a specific period, just like a CD. This can be renewed annually or guaranteed for an extended period of years which is known as a multi-year guaranteed fixed annuity. The contract is guaranteed to not lose money as is also guaranteed to grow in value.
Indexed annuities also have a fixed rate but also several different external indexes that are tracked. Money can be allocated to either the fixed rate, any of the available indices, or any combination that the owner chooses. Options are purchased on the indices chosen.
If the index increases in value, the option is exercised and a portion of the gain is credited to the annuity contract value as interest. This rate often exceeds the guaranteed rate available in a fixed annuity. The contract is guaranteed to not lose money but is not guaranteed to grow.
Free Withdrawals
Many fixed annuities offer free withdrawals that only equal interest earnings, a few offer no withdrawals and some will offer up to 10% annually. This differs substantially from fixed indexed annuities where the vast majority of contracts allow 10% free withdrawals annually. There are exceptions but the general rule is as stated.
Renewal After Surrender Term
Both types of annuities have surrender periods that last multiple years. Let’s use five years as an example.
With many fixed annuities, after the five years have passed, the contract owner has 30 days to either move the money or the contract will enter a new five-year surrender period.
This can force the contract owner to make another long-term commitment at a not-so-ideal time. Some fixed annuities are what I call open-ended, meaning that after the five-year period, the contract renews on an annual basis without entering a new surrender period.
All fixed indexed annuities can be considered open-ended so the contract owner can take time to decide without potentially being assessed new surrender penalties.
Which is Better a Fixed Annuity or an Indexed Annuity?
While fixed annuities and fixed indexed annuity contracts have the same foundation and identical protection, there are many other similarities and differences. You must consult with an advisor who is well-versed in both before deciding which type of contract is both suitable and in your best interest.
Podcast Episode: Fixed Annuities vs Fixed Indexed Annuities
