Fixed vs. Fixed Indexed Annuities: What Are They, How Are They Different?
Annuities have long had a place in money management and estate planning. During the Middle Ages, feudal barons and kings issued annuities to cover the high costs of near-constant warfare or reward their loyal soldiers. Over the years, annuities have evolved and have been used for many reasons. Income, savings, and safety are reasons annuities are so popular.
But, while annuities have been around for thousands of years, it’s only in the 20th Century that they have evolved as a variety of flexible, risk-averse alternatives to Wall Street.
Two of the most popular iterations of annuities are “fixed” and “fixed indexed.” While these terms sound similar, the design of fixed and fixed indexed annuities differs significantly. If you are considering purchasing one, you should be aware of the differences.
What is a fixed annuity?
A fixed annuity is perhaps the most straightforward type of annuity. A fixed annuity, a lump sum, or a series of monthly payments is exchanged for a guaranteed income stream. The contract between the purchaser of the annuity and the annuity company defines all the terms and details.
A fixed annuity pays a specific amount of interest for a specific amount of time. The interest earned grows tax-deferred at a fixed rate for the specified contractual term. The annuitization phase of the policy is triggered when you start receiving payments.
Benefits of a fixed annuity
Fixed annuities provide several benefits, especially for people who want to reduce risk. Fixed guaranteed interest, tax-deferred growth, no fees or expenses, the interest rate earned is what you receive.
Here are some of the upsides:
- A fixed annuity can convert to an income stream at the end of the term period.
- Savings may grow faster Annuities grow tax-deferred. They earn interest each year, but you do not have tax exposure until the funds are used. Deferring taxes helps your savings grow faster.
- Safety Many people are weary of exposure to market volatility by using a fixed-rate annuity to add stability to their portfolio.
- Using a fixed interest rate annuity means you will know its annual interest rate and the precise value of your account at the end of the term.
What is a Fixed Indexed Annuity?
Fixed Indexed Annuities provide mainly the same benefits as fixed annuities, with one intriguing difference. Fixed indexed annuities offer upside potential because the annual yield is tied to an outside source, such as an index.
Indexed annuities base their performance on an underlying index, such as the well-known S&P 500 ® Composite Stock Price Index. However, although a fixed indexed annuity’s benchmark follows an index, your money is never exposed to market risk.
Benefits of a fixed indexed annuity
Fixed indexed annuities have become very popular over the last few years, especially as they have added unique enhancements to help with things such as long-term care. They are an excellent choice for those who want the potential of higher gains but are still wary of market risk.
In addition to having most of the benefits of fixed annuities, fixed indexed annuities provide additional upsides such as:
- Potential for higher earnings. Earnings from fixed indexed annuities may have a potentially higher rate of return than a fixed annuity.
- Protection against risk. In exchange for accepting limited profits, people who purchase a fixed indexed annuity receive guarantees against the loss of principle. However, this protection is subject to the issuing company’s claims-paying ability.
Dealing with an authorized and licensed professional can help you select the right product for your specific need.