Fixed vs. Variable
vs. Indexed Annuities
Annuities can work in different ways. Understanding how fixed, variable, and indexed annuities differ can help you ask better questions about the role an annuity may play in a retirement plan.
Educational information from Rosenberg Wealth Management. This material is not individualized investment advice.
Three Types of Annuities.
Different Ways to Work.
The word “annuity” describes a broad category of insurance products. Within that category, fixed, variable, and indexed annuities can have very different features, risks, costs, and ways of generating retirement income.
The differences can matter. Before comparing one annuity with another, it can be useful to understand how each type generally works and what determines the value or income you may receive.
It is not simply which type offers the highest potential return. The more useful question is how the product's features and tradeoffs relate to its intended role in a retirement plan.
Fixed. Variable. Indexed.
What Is the Difference?
Each type of annuity approaches growth, income, risk, and market participation differently. Understanding those differences is an important first step before evaluating whether any annuity fits your retirement objectives.
Fixed Annuities
A fixed annuity generally provides a stated interest rate for a specified period or according to the terms of the contract. The insurance company assumes responsibility for the investment performance supporting the contract.
Variable Annuities
A variable annuity generally allows the contract owner to allocate money among investment options. The value of the account can rise or fall based on the performance of those investments.
Indexed Annuities
An indexed annuity generally credits interest based, in part, on the performance of a specified market index, subject to the contract's terms. The method used to calculate interest can vary significantly from one contract to another.
The Differences Go Beyond
How Interest Is Credited.
When comparing annuities, it can be helpful to look beyond the headline interest or growth potential. The way a contract handles market exposure, guarantees, fees, withdrawals, and access to your money can be just as important.
How Does Each Type
Generally Work?
Fixed Annuities
With a fixed annuity, the insurance company generally credits interest according to the terms of the contract. Depending on the type of fixed annuity, the interest rate may be guaranteed for a specified period or may be adjusted according to the contract.
This structure can appeal to someone who places greater importance on predictability than on direct participation in market performance.
Variable Annuities
A variable annuity typically offers a selection of investment options. The contract's account value generally changes based on the performance of the investments selected.
Because the underlying investments can gain or lose value, variable annuities generally involve greater investment market exposure than fixed annuities.
Indexed Annuities
An indexed annuity generally uses a formula tied to the performance of a specified market index to determine how much interest is credited to the contract.
The calculation can include features such as participation rates, caps, spreads, or other contractual provisions. As a result, the performance of the index itself does not necessarily equal the interest credited to the annuity.
An index-linked annuity is not the same thing as investing directly in the index. The contract determines how index performance is measured and how interest is credited.
The Type of Annuity
Is Only the Beginning.
Two annuities in the same general category can have very different contracts. Looking at the product type alone may not tell you enough about how the annuity works, what it costs, or how accessible your money may be.
Guarantees
Understand what is guaranteed, for how long, and which guarantees depend on the financial strength and claims-paying ability of the issuing insurance company.
Fees & Expenses
Costs can vary substantially. Review contract charges, investment expenses, rider costs, and other fees that may affect the value or income potential of the contract.
Withdrawal Rules
Some contracts may include surrender periods, withdrawal charges, or other limitations. Understanding access to your money is particularly important when retirement income is involved.
Income Features
Optional income benefits or riders can have their own costs and contractual rules. It is important to understand how an income feature actually works rather than focusing only on its name.
Time Horizon
An annuity may be designed with a particular time frame in mind. Consider how long the money may need to remain invested and when you may need access to it.
Overall Retirement Plan
An annuity should be considered in the context of the broader retirement picture, including other income sources, savings, liquidity needs, and long-term objectives.
The right comparison is not simply “fixed vs. variable vs. indexed.” It is understanding what a specific contract is designed to do, what you give up in exchange for its features, and whether those characteristics fit the role you are considering for it.
Start With the Role.
Then Compare the Contract.
Annuities can serve different purposes in a retirement plan. Before focusing on rates, features, or potential growth, it can be useful to identify what you are trying to accomplish with the money.
Are You Looking for Predictability?
If predictable income or a defined interest structure is important, understand what guarantees the contract provides and the conditions attached to those guarantees.
How Much Market Exposure Do You Want?
Different annuities provide different levels and forms of exposure to investment or market performance. Consider how that exposure fits with the rest of your retirement assets.
When Might You Need the Money?
Retirement planning often requires access to assets at different times. Review surrender periods, withdrawal provisions, and other restrictions before committing money to a contract.
What Are You Paying for?
Additional guarantees, riders, investment options, and other contract features may involve additional costs. Understand what each feature is designed to provide and what it costs.
How Does It Fit With Your Other Income?
Social Security, pensions, investment accounts, cash reserves, and other resources can all play a role. An annuity should be viewed within the context of the broader retirement income picture.
A product comparison becomes more meaningful when you first know what problem you are trying to solve. The goal is not necessarily to find the most attractive feature, rate, or benefit — but to understand how the contract works and whether its characteristics align with the purpose you have in mind.
What Should You Remember
When Comparing Annuities?
There Is No Single “Best” Type
Fixed, variable, and indexed annuities are structured differently. Whether one is appropriate depends on the role being considered, the contract terms, and the individual's circumstances.
Look Beyond the Headline Rate
Interest rates, potential growth, or income figures are only part of the picture. Guarantees, fees, restrictions, and other contract provisions can also affect the overall value of an annuity.
Understand How the Contract Works
Two products that sound similar may use very different methods for crediting interest, calculating benefits, managing withdrawals, or determining costs.
Liquidity Matters
Retirement assets may need to serve different purposes at different times. Understanding surrender periods and withdrawal provisions is an important part of evaluating an annuity.
Consider the Bigger Retirement Picture
Annuity decisions should be considered alongside other sources of retirement income, savings, investment accounts, liquidity needs, and long-term objectives.
Read the Contract
The specific contract ultimately determines the features, costs, guarantees, limitations, and obligations involved. Product names alone do not tell the entire story.
THE BOTTOM LINE Comparing annuities is less about choosing a label and more about understanding how a specific contract works — and whether its characteristics make sense for the role it is intended to play.
Understanding the Differences
Is a Good Place to Start.
Fixed, variable, and indexed annuities can have very different characteristics. If you are considering an annuity as part of your retirement planning, a conversation can help you better understand the questions worth asking about your options.
START WITH A CONVERSATIONIMPORTANT INFORMATION
The information presented in this article is for educational and informational purposes only and is not intended to provide individualized investment, tax, or legal advice. References to annuities, guarantees, income, interest, growth, or other financial concepts are provided for general educational purposes and should not be interpreted as a recommendation or solicitation to purchase any particular financial product.
Annuity guarantees and protections are subject to the claims-paying ability of the issuing insurance company and the specific terms, conditions, limitations, and exclusions of the applicable contract. Features, fees, surrender periods, withdrawal provisions, interest crediting methods, and available benefits vary by product and issuing company.
Variable annuities involve investment risk, including the possible loss of principal. Indexed annuities are not direct investments in a market index, and interest credited under an indexed annuity is determined according to the terms and methodology of the specific contract.
Individual circumstances vary. Rosenberg Wealth Management encourages individuals to carefully review applicable contracts and seek appropriate professional guidance regarding their own financial circumstances.