• Which Places Are Safe
    • Fixed Annuities >
      • Fixed Annuities Overview
      • Fixed Annuity Benefits
      • How Fixed Rate Annuities Work
      • How Fixed Index Annuities Work
      • Differences Between Fixed and Variable Annuities
    • Social Security >
      • Social Security Overview
      • How Does Social Security Work
      • What Are My Social Security Benefits
      • What If My Spouse Is Deceased
      • Strategies For Maximizing Social Security Benefits
      • How To Estimate Your Social Security Benefits
    • Life Insurance >
      • Life Insurance Overview
      • Questions To Ask Yourself About Life Insurance
      • Basic Considerations For Your Life Insurance Needs
      • Common Uses For Life Insurance
      • Term Life Insurance
      • Permanent Life Insurance
    • Savings Bonds >
      • Savings Bonds Overview
      • How Savings Bonds Work
      • Savings Bonds Yields
      • Tax Advantages of Savings Bonds
      • Older Bonds / Baby Bonds
    • Banks and Credit Unions >
      • Banks and Credit Unions Overview
      • Certificates Of Deposits
      • Money Market Accounts
      • Savings Accounts
    • Critical Illness Insurance
    • Risk Money Places
  • How Safe Are They
    • FDIC - Federal Deposit Insurance Commission >
      • FDIC Overview
      • What Does The FDIC Cover?
      • How Does The FDIC Work?
      • Who Is The CDARS?
    • NCUA - National Credit Union Association
    • How Strong Is My Bank Or Insurance Company?
    • What Happens If The Bank Fails
    • What Happens If The Insurance Company Fails
    • Guaranty Associations (External Link)
  • Concepts
    • Wealth Transfer
    • Personal Pension Plan
    • Basic Money Math >
      • HOW FAST MONEY DOUBLES - RULE OF 72
      • Annual Percentage Yield Vs. Annual Interest Rate
      • Compound Vs. Simple Interest
      • Rate of Return
    • Financial Concepts >
      • Split Funding
      • Tax Deferral
      • Saving Too Conservative
      • Yield Ladders
      • Liquidity
    • Identity Theft Protection
  • Consumer Guides
  • Videos
  • Safe Money News
    • Current Issue
    • Digital Magazine
    • Subscribe
    • Contributors >
      • Raymond J. Ohlson
      • Steve Dinnen
      • TMA Small Business Accounting
      • Norm Wilkens
      • David Barker J.D.
      • Leo LaGrotte
      • Kim O'Brien
  • Resources
    • Ask A Question
    • FAQ
    • Financial Dictionary
    • Financial Basics Quiz
    • Calculators
    • Useful Tools and Links
  • Which Places Are Safe
    • Fixed Annuities >
      • Fixed Annuities Overview
      • Fixed Annuity Benefits
      • How Fixed Rate Annuities Work
      • How Fixed Index Annuities Work
      • Differences Between Fixed and Variable Annuities
    • Social Security >
      • Social Security Overview
      • How Does Social Security Work
      • What Are My Social Security Benefits
      • What If My Spouse Is Deceased
      • Strategies For Maximizing Social Security Benefits
      • How To Estimate Your Social Security Benefits
    • Life Insurance >
      • Life Insurance Overview
      • Questions To Ask Yourself About Life Insurance
      • Basic Considerations For Your Life Insurance Needs
      • Common Uses For Life Insurance
      • Term Life Insurance
      • Permanent Life Insurance
    • Savings Bonds >
      • Savings Bonds Overview
      • How Savings Bonds Work
      • Savings Bonds Yields
      • Tax Advantages of Savings Bonds
      • Older Bonds / Baby Bonds
    • Banks and Credit Unions >
      • Banks and Credit Unions Overview
      • Certificates Of Deposits
      • Money Market Accounts
      • Savings Accounts
    • Critical Illness Insurance
    • Risk Money Places
  • How Safe Are They
    • FDIC - Federal Deposit Insurance Commission >
      • FDIC Overview
      • What Does The FDIC Cover?
      • How Does The FDIC Work?
      • Who Is The CDARS?
    • NCUA - National Credit Union Association
    • How Strong Is My Bank Or Insurance Company?
    • What Happens If The Bank Fails
    • What Happens If The Insurance Company Fails
    • Guaranty Associations (External Link)
  • Concepts
    • Wealth Transfer
    • Personal Pension Plan
    • Basic Money Math >
      • HOW FAST MONEY DOUBLES - RULE OF 72
      • Annual Percentage Yield Vs. Annual Interest Rate
      • Compound Vs. Simple Interest
      • Rate of Return
    • Financial Concepts >
      • Split Funding
      • Tax Deferral
      • Saving Too Conservative
      • Yield Ladders
      • Liquidity
    • Identity Theft Protection
  • Consumer Guides
  • Videos
  • Safe Money News
    • Current Issue
    • Digital Magazine
    • Subscribe
    • Contributors >
      • Raymond J. Ohlson
      • Steve Dinnen
      • TMA Small Business Accounting
      • Norm Wilkens
      • David Barker J.D.
      • Leo LaGrotte
      • Kim O'Brien
  • Resources
    • Ask A Question
    • FAQ
    • Financial Dictionary
    • Financial Basics Quiz
    • Calculators
    • Useful Tools and Links

how Fixed Index Annuities work

(Watch Our Fixed Index Annuities 101 Video)
Fixed index annuities link the interest paid to the performance of an index and state what your participation in the index will be.

How Index Annuities Earn Interest
Fixed annuities provide a minimum guaranteed interest rate. If the insurance company believes it can pay extra interest from their general account, above and beyond its minimum guarantee, it uses the extra interest to link the earning of interest to the performance of an external index for the period. The major difference between a fixed rate annuity and a fixed index annuity is in the crediting of excess interest above the minimum guarantee.

How Do They Pay Interest?
It might be easier if we compare how an index annuity pays interest with the way a bank pays interest. As you know, when you place your money with the bank they invest this money, earn a return, and, after subtracting their costs, pay you net interest rate for a stated period. Your principal does not fluctuate, but the interest you receive can and usually does fluctuate from period to period. Furthermore, this fluctuation can be extreme. But in any case, this sums up how a CD works. 

An index annuity operates the same way, except that you place your money with an insurance company instead of a bank. When you place your money with the insurance company they invest this money, earn a return, and subtract their costs. The difference between the CD and the index annuity is that the amount of interest paid is linked to the movement of an external index. When the index goes up, the amount of interest earned increases. However, because this is a safe money place and not an investment, the index annuity does not share in any decreases of the index. 
Picture
  • The Benefits of FIXED Annuities
  • How FIXED Annuities Work
  • The Differences Between FIXED and VARIABLE Annuities
Picture
Picture
Life Insurance

Picture
Savings Bonds

Picture
Social Security Planning

Picture
Critical Illness Insurance

Picture
Banks & Credit Unions

Picture
What Do They Invest In?
A score of years ago you could say that banks earned their money by making loans and that insurance companies made their money by primarily buying bonds, but only half of that is still true. The change is that due to the securitization of debt - a topic for another lengthy discussion - many banks own few direct loans, but rather own lots of bonds, possibly some preferred stocks, and perhaps some real estate. Conversely, the bulk of insurance company holdings are still bonds. They may own a smattering of direct loans, possibly some preferred stocks, and perhaps some real estate, but by and large insurance companies buy bonds because of the predictability of the income. If you look back over time, the stock market has gone up many more years than it has gone down, but when it does go down it can hurt, sometimes a lot!

What the index annuity lets you do is benefit in the up periods without sharing in the losses. The worst thing that can happen, from a market-risk point of view, with an index annuity is that you don’t lose money – you can never lose principal or credited interest if the index declines. 

What’s The Catch? 
Though it’s not really a “catch,” because it costs insurance companies to provide this valuable protection, you probably are not going to get all of the upside. 

One Year Or Multiple Year Rate Lock-Ins
All index annuities guarantee the rate of participation in the index annuity for a full year. Typically, an index annuity will guarantee index participation for one year at a time and declare the new index participation on the policy anniversary for the next year. Some index annuities lock-in all of the initial participation elements for two years, three years, or even for the entire penalty period of the annuity. 

The amount of index participation may be expressed in many different ways. Some index annuities state you will receive a stated percentage of any calculated index gains over the periods, others may give you all the calculated index gain up to a certain interest ceiling or cap, others may use averaging or other variations. No index-link method is good or bad and any method can be the winner in a given period. The key is understanding how it works. If you cannot understand the method, do not get the annuity.

How Much Interest?
The index annuity offers an alternative to concerns over rising interest rates by linking interest to changes in an equity index. An index annuity benefits in increases calculated for the index over a period, but even if the index goes down you can never lose principal or previously credited interest. The highest index annuity interest rate credited for one year was over 40%. In 2002 and 2008 the major stock market indices went down and index annuities linked to these indices credited 0% for the year, but no previous interest was lost. Index annuities are designed to provide a longterm return somewhere between stock market vehicles and other safe money places – always protecting principal and credited interest from market risk - and they have performed as intended.

Minimum Guarantee
A fixed annuity guarantees to credit a minimum yield and that is what makes a fixed annuity a fixed annuity instead of an investment. In the case of an index annuity the minimum guarantee is usually structured to simply protect the premium and perhaps pay back a few extra bucks, rather than crediting a minimum interest rate each year.

For example, an index annuity might guarantee to return a minimum of $1.10 for each original $1 of premium at the end of seven years. If the index does not produce at least this minimum index-linked return the insurance company will retroactively go back credit enough interest to reach $1.10.

About Safe Money Places
Safe Money Places® and this website are operated by SMP International LLC. 
If you have an questions or concerns, please contact us at 1-877-844-0900 OR contact us by filling out our form. 

Safe Money Places® does not warrant anything on this website, although we hope everything is accurate. We do not provide tax, legal, accounting, or investment advice. You need to do your own homework and consult your own experts on your personal situation. This website is protected by applicable copyright laws. You may make or print one copy of any material for personal use, further copying or distributing is prohibited without prior written permission.
​
Safe Money Places® is a registered trademark of SMP International LLC. Copyright 2005 - 2017
  • Which Places Are Safe
    • Fixed Annuities >
      • Fixed Annuities Overview
      • Fixed Annuity Benefits
      • How Fixed Rate Annuities Work
      • How Fixed Index Annuities Work
      • Differences Between Fixed and Variable Annuities
    • Social Security >
      • Social Security Overview
      • How Does Social Security Work
      • What Are My Social Security Benefits
      • What If My Spouse Is Deceased
      • Strategies For Maximizing Social Security Benefits
      • How To Estimate Your Social Security Benefits
    • Life Insurance >
      • Life Insurance Overview
      • Questions To Ask Yourself About Life Insurance
      • Basic Considerations For Your Life Insurance Needs
      • Common Uses For Life Insurance
      • Term Life Insurance
      • Permanent Life Insurance
    • Savings Bonds >
      • Savings Bonds Overview
      • How Savings Bonds Work
      • Savings Bonds Yields
      • Tax Advantages of Savings Bonds
      • Older Bonds / Baby Bonds
    • Banks and Credit Unions >
      • Banks and Credit Unions Overview
      • Certificates Of Deposits
      • Money Market Accounts
      • Savings Accounts
    • Critical Illness Insurance
    • Risk Money Places
  • How Safe Are They
    • FDIC - Federal Deposit Insurance Commission >
      • FDIC Overview
      • What Does The FDIC Cover?
      • How Does The FDIC Work?
      • Who Is The CDARS?
    • NCUA - National Credit Union Association
    • How Strong Is My Bank Or Insurance Company?
    • What Happens If The Bank Fails
    • What Happens If The Insurance Company Fails
    • Guaranty Associations (External Link)
  • Concepts
    • Wealth Transfer
    • Personal Pension Plan
    • Basic Money Math >
      • HOW FAST MONEY DOUBLES - RULE OF 72
      • Annual Percentage Yield Vs. Annual Interest Rate
      • Compound Vs. Simple Interest
      • Rate of Return
    • Financial Concepts >
      • Split Funding
      • Tax Deferral
      • Saving Too Conservative
      • Yield Ladders
      • Liquidity
    • Identity Theft Protection
  • Consumer Guides
  • Videos
  • Safe Money News
    • Current Issue
    • Digital Magazine
    • Subscribe
    • Contributors >
      • Raymond J. Ohlson
      • Steve Dinnen
      • TMA Small Business Accounting
      • Norm Wilkens
      • David Barker J.D.
      • Leo LaGrotte
      • Kim O'Brien
  • Resources
    • Ask A Question
    • FAQ
    • Financial Dictionary
    • Financial Basics Quiz
    • Calculators
    • Useful Tools and Links