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Disadvantages of Fixed Index Annuities

Stan Haithcock
March 13, 2025
Disadvantages-of-Fixed-Index-Annuities

Hi, Stan The Annuity Man. Today's topic is the disadvantages of Fixed Index Annuities. We will cover everything, including the benefits, because all annuity types have advantages and limitations. By the end of this blog, you’ll understand how they work and whether they fit with what you’re trying to achieve. I also encourage you to check out the video "What is Lifetime Income Benefit Rider?" because it correlates with what we’re discussing today regarding Fixed Index Annuities.

What is a Fixed Index Annuity?

Okay, we have a lot to cover on Fixed Index Annuities, so I’m going to go over what a Fixed Index Annuity is, how it works, what it solves for, its limitations, and benefits. Finally, I’ll also talk about how it fits into your portfolio and if you even need one after getting all the information. You need to understand the limitations and benefits before pulling the trigger and putting one in your portfolio. Also, hang in there because, at the end of this video, I will tell you how to get a free book I’ve written on Fixed Index Annuities and a free book on Income Riders.

Understanding How Fixed Index Annuities Work

So, what is a Fixed Index Annuity? It was designed in 1995 to compete with CD returns. Remember that—CD returns, not the market, and definitely not how it's pitched or how you see it on TV. The bad steak dinner seminars, the Saturday morning radio shows that sound too good to be true, all of that. If it sounds too good to be true, it is—every single time, without exception, with annuities. Annuities are contracts, and you need to understand what's in the contract.

A Fixed Index Annuity is a contract that’s fixed. It’s going to protect your principal. The upside gains, if any, are based on a call option; we’ll discuss that in more depth. But it's limited, and historically, it creates CD-type returns. Are there years when it does better? Of course. But generally, you should expect CD-type returns. That’s a Fixed Index Annuity.

The Disadvantages of Fixed Index Annuities

Before we get to the disadvantages and limitations, let’s talk about how they work or how the sausage is made, for lack of a better phrase. In essence, a Fixed Index Annuity is a Fixed Annuity. The gains are attached to an index call option, typically based on the S&P 500, not including dividends. For example, if you buy it on April 7th, you get to lock in any gains on the following April 7th—if there are any. These gains are up to the cap or limitation that the annuity company puts in place, which by the way, they can change at their discretion, typically every year.

You can also add an Income Benefit Rider to the policy at the time of application if one of your goals is future income. Draw a line down the middle of the page. On one side is the index option side, and on the other side is the Income Benefit side. Two separate calculations, but you can have principal protection with the CD return on one side and a future income benefit on the other side.

What Fixed Index Annuities Solve For

So, what do Fixed Index Annuities solve for? It's pretty basic. The fixed part of a Fixed Index Annuity is principal protection. That’s the first thing. It can also solve for CD-type returns, maybe a little better in some years, but generally, that’s what they do. It can also solve for future income guarantees if you attach an Income Rider to the policy. That’s what Fixed Index Annuities solve for.

The Disadvantages of Fixed Index Annuities

Now, let’s talk about the disadvantages of Fixed Index Annuities. People often ask me, "Stan, do you hate Fixed Index Annuities?" No, they’re Fixed Annuities. They do exactly what they say they’re going to do, which is provide CD-type returns. They’re an efficient way to deliver future income guarantees using a Lifetime Income Benefit Rider. However, a lot of the disadvantages are related to the sales message. Here’s what’s happening: market upside with no downside.

They use the word "hybrid." By the way, hybrid’s a car, hybrid’s a plant, hybrid’s a mattress. If someone uses the word "hybrid," they’re trying to sell you a Fixed Index Annuity. It’s a Fixed Index Annuity. They’re just trying to polish it up and make it sound shiny. It’s a contract. Most of the negativity around this product is due to the over-hyped sales pitch. Again, if it sounds too good to be true, it is. So, contractually, there are limitations on the upside. There’s no market upside with no downside risk. That sounds fantastic, but it doesn’t exist. It’s like saying, "If you take this pill, you’ll get six-pack abs." Doesn’t exist.

The Reality Behind Upfront Bonuses

If you want a CD-type product and the possibility of getting a little better than CD-type returns, then Fixed Index Annuities work. Unfortunately, the unregulated sales message is part of the issue. It’s not the carrier’s fault that someone is saying something crazy about the product, but agents and advisors need to self-regulate. They can’t just pitch the good things or hypothetical, theoretical, back-tested, hopeful return scenarios. You need to tell people about the historical returns. You need to explain that in 1995, they were designed for CD-type returns. And they’re also an efficient way to deliver future income with an Income Benefit Rider. The negatives mainly come from the perception and stories in the sales environment.

Examples of Negative Messaging

Let me give some specific examples of the negative messaging surrounding Fixed Index Annuities. Number one: they’re often sold with "upfront bonuses." Understand this—no philanthropist at annuity companies is waking up and saying, "I think I’ll give money away to the public because I love them." Upfront bonuses are not free money. It’s just part of the overall contractual guarantee. Don’t tell your spouse, "They’re giving us free money." No, it’s not free money. There are catches.

Another example: people often call and say, "Hey, Stan, I just bought an 8% annuity." No, you didn’t. You bought a Lifetime Income Benefit Rider that’s growing at 8%. That’s not yield—it’s monopoly money and can only be used to calculate your first income payment.

The Limitations of Fixed Index Annuities

A couple of other negatives: First, the annuity companies can change the rules for calculating index option gains. That could be good or bad for you, but you must understand that. Also, the call options, like the S&P 500, don’t include dividends. This is important because, historically, over 50% of the returns of the S&P 500 are dividend-based. So, the growth during the year, from one anniversary to the next, does not include dividends.

Finally, one of the bigger limitations is the Income Benefit Rider attached to the Fixed Index Annuity. Most of these riders have an annual fee that’s deducted from the accumulation value side. The fee is taken from the accumulation side, which limits the upside. The fee increases each year as the rider grows, and when you lock it in, it locks in that annual fee for the life of the policy.

The Advantages of Fixed Index Annuities

Now, let’s talk about the advantages and benefits of Fixed Index Annuities. First, they’re principal-protected. You’re never going to lose money, and that’s a good thing. Second, any gains from the index options strategy, although limited, are locked in permanently, so they’ll never go below that amount. I like that. There are liquidity provisions with most of them. You can typically take out 10% of your money for liquidity if needed. If you do that, it may interrupt some of the guarantees, like if you have an Income Benefit Rider attached, but it’s still a good option.

At the end of the day, Fixed Index Annuities are not bad products. They’re enhanced CD products, and you need to understand how they work. In combination with other safe money strategies, a Fixed Index Annuity might work for you, especially if you need future income. Shop all the Income Riders and find the best contractual guarantee for you.

Conclusion

Hey, thanks for hanging in there with me. As promised, you can download my books directly from The Annuity Man One of them is the Fixed Index Annuity Owner’s Manual, an easy read that you’ll find helpful. The other is the Income Rider Owner’s Manual. No shipping involved—just download them at your convenience. And don’t worry, we won’t bother you with calls or make you attend any seminars. We're here to provide value, and if you want to contact us, feel free to do so.

Lastly, please subscribe to my Stan The Annuity Man YouTube channel. I release informative videos all the time. They're not salesy or pitchy—you’ll enjoy them. My name is Stan The Annuity Man, and I'll see you on the next blog.

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