Are Indexed Annuities a Good Investment?

Indexed annuities are not investments in the traditional sense.

They are insurance contracts.

That distinction matters because the expectations should be completely different.

If you are looking for stock market growth, you should compare market investments.

If you are looking for contractual guarantees, an annuity may have a role.

The mistake is trying to make one product do both jobs.

Key Takeaways

• Indexed annuities are insurance contracts, not direct market investments.
• Future indexed returns are not guaranteed.
• Principal protection is one of the contractual guarantees of a Fixed Index Annuity.
• FIAs can be used as the underlying contract for an Income Rider.
• Large bonuses and hypothetical projections should not drive the purchase decision.
• If guaranteed accumulation is the goal, compare FIAs with MYGAs.

What Is an Indexed Annuity?

A Fixed Index Annuity is a fixed insurance contract issued by a life insurance company.

It is not a stock, ETF, mutual fund, or security.

Potential interest is calculated using the performance of an external index according to the contract's crediting methodology.

That can involve:

• caps
• spreads
• participation rates
• other crediting provisions

You are not directly invested in the index.

Why Calling It an Investment Creates Problems

Investments are generally purchased because you are willing to accept risk in pursuit of returns.

Annuities are purchased to transfer specific risks to an insurance company.

Those are different objectives.

When someone treats an indexed annuity like a growth investment, expectations can quickly become disconnected from what the contract actually guarantees.

What Does an Indexed Annuity Guarantee?

The principal protection is contractual.

The future indexed return is not.

That is the key distinction.

The contract protects your principal from market losses according to its terms, but there is no guarantee that you will earn a particular indexed return every year.

The credited interest may be positive.

It may also be zero.

Why Indexed Returns Are Hard to Predict

The future return depends on the index and the crediting terms.

With many Fixed Index Annuities, caps, participation rates, or other crediting provisions can change after the initial period, subject to the contract.

That means the first-year illustration does not necessarily tell you what years two through ten will look like.

The future accumulation is uncertain.

Indexed Annuities Should Not Be Bought for Market Growth

If you want market growth, use products designed for market growth.

A Fixed Index Annuity is not designed to give you the same experience as directly owning stocks.

You are trading unrestricted market participation for principal protection.

That can be appropriate if protection is the objective.

It is not appropriate if you are expecting full market returns.

What About Upfront Bonuses?

Large upfront bonuses are often used to market indexed annuities.

A bonus may look attractive, but it is part of the overall economics of the contract.

There are not 125 pennies in the dollar because the product advertises a 25% bonus.

The bonus may apply to an income base or other benefit calculation rather than immediately accessible cash value.

The entire contract needs to be evaluated.

How We Use Fixed Index Annuities

One practical use of a Fixed Index Annuity is as the underlying contract for an Income Rider.

If you need guaranteed lifetime income beginning in the future, an Income Rider can provide that contractual guarantee.

In that situation, the important number is the lifetime income amount.

The indexed accumulation story becomes secondary.

What Is an Income Rider?

An Income Rider is an attached benefit designed to provide guaranteed lifetime income.

The rider may use a separate benefit base to calculate future income.

That benefit base is not the same thing as cash value.

When comparing Income Riders, focus on:

• the contractual income amount
• the income start date
• rider costs
• single-life or joint-life structure
• carrier financial strength

Those are the factors that directly relate to the guarantee.

Indexed Annuities vs. MYGAs

If your goal is guaranteed accumulation, a MYGA may be more straightforward.

A Multi-Year Guarantee Annuity provides a guaranteed interest rate for a specific period.

A Fixed Index Annuity provides potential indexed interest.

That is a major difference.

If certainty is the goal, compare the contractual rate of the MYGA with the non-guaranteed indexed crediting potential of the FIA.

Annuities Solve Contractual Problems

Annuities generally solve four primary objectives using the PILL framework:

• Principal Protection
• Income for Life
• Legacy
• Long-Term Care

There is no category for market growth.

That is not what annuities are primarily designed to solve.

Start With Two Questions

Before considering an indexed annuity, ask:

What do you want the money to contractually do?

When do you want those contractual guarantees to start?

If your answer is "I want market growth," an annuity is probably not the correct product.

If the answer is principal protection or future lifetime income, then a fixed annuity may deserve consideration.

Review the Surrender Period

Fixed Index Annuities are long-term contracts.

Many have surrender charge periods that can last for several years.

If you need to withdraw more than the contract allows during that period, surrender charges can apply.

That is another reason not to buy based on a sales pitch.

You may be committed to the contract for years.

Where to Compare Annuity Guarantees

Use our annuity calculators to compare current contractual guarantees from multiple insurance companies.

If your goal is guaranteed accumulation, compare MYGA rates.

If your goal is lifetime income, compare current contractual Income Rider guarantees rather than hypothetical indexed returns.

The Bottom Line

Are indexed annuities a good investment?

That is the wrong framework.

They are insurance contracts.

Fixed Index Annuities can provide principal protection and can also serve as the delivery system for guaranteed lifetime income through an Income Rider.

If you are buying one for market growth, hypothetical returns, or a large bonus, you are evaluating the contract for something it does not guarantee.

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