Fixed Index Annuities Explained

Under the Hood of Fixed Index Annuities

A fixed index annuity (FIA) is a long-term, tax-deferred retirement savings vehicle offering growth potential linked to a market index, subject to a cap, participation rate, spread or performance trigger crediting method. It also provides protection from index-based market downturns, since index-linked interest is typically never less than zero. 

An FIA is an insurance contract, not a registered security or stock market investment. You aren't invested directly in any index. Within a diversified retirement strategy, an FIA may help reduce exposure to the volatility of market-based investments like mutual funds, stocks, and bonds. 

Whether an FIA is right for you depends on your financial situation, time horizon, and goals. Withdrawals may be subject to surrender charges, and those taken before age 59½ may incur a 10% federal tax penalty.

How your premium works behind the scenes

Selecting your Crediting Strategy

The growth of your premium is shaped by one or more crediting options you choose:

• Cap: Limits the maximum interest you can earn in a period. 

• Participation rate: Determines what percentage of the index's gain is credited to your account. 

• Spread: Is a percentage subtracted from the index gain before interest is credited. 

• Performance trigger: Credits a fixed, pre-declared rate whenever the index return is flat or positive, and credits zero interest—with no market-based loss—when the index return is negative. 

Managing the portfolio that supports your guarantees

The insurance company invests policyholder premiums in conservative securities, and a small portion is used to purchase a call option (or call spread) on an index, structured to match the FIA’s crediting features. This call is what allows your interest to track index growth while your principal remains protected against market-based losses.

One important detail to note: your interest is tied only to the price appreciation of the index; it does not include dividends paid by the underlying companies.

Understanding the call option bidding process

Insurance companies buy these call options through a competitive bidding process among major investment banks. The better the price they secure, the stronger the crediting terms they can offer you. 

When the index rises, the return from the expiring call goes toward crediting your account, subject to any cap, participation rate, spread or performance trigger that applies to your contract. 

Let’s look at an example. Say your contract has a 7% cap and the index rises 10% over the crediting period. Because the increase exceeds the cap, the amount credited to your contract is limited to 7%. The investment bank pays the insurance company a return matching that cap, and the full amount goes toward crediting your contract. The company doesn’t deduct the cost of the call or the bidding process from the amount credited to you. 

When the index declines, the call option simply expires, and the insurance company absorbs 100% of their cost—not you. Your principal remains protected against market-based losses.

The final word on FIAs

Market uncertainty can be unsettling, especially when your retirement savings are on the line. A fixed index annuity offers a measure of reassurance by protecting against market-based losses. An FIA lets you transfer some or all the risk of market-based losses to the insurance company¹, while giving you access to growth potential designed to be competitive.