This article is part of the Retirement Financial Life Equation (RFLE) series. It was initially published on July 24, 2019, and updated in January 2026
In my last article, I looked at immediate fixed-income annuities and discussed whether I might want to include them as a part of my overall retirement income plan.
Guaranteed payments for life are their strong suit (helps mitigate “longevity risk”). But, as I noted, one of my major concerns about immediate fixed-income annuities is that the payouts are, well, fixed—for life!
I was reluctant to get “locked-in” to a payout in the then-current low-interest environment. More importantly, I was hesitant due to the lack of an “upside”—fixed-income annuities don’t increase with inflation (unless you can find one that is inflation-adjusted). Therefore, they could lose purchasing power over time.
So, at least back in 2019, I decided not to pull the trigger on an immediate annuity. If I chose to purchase one in the future, I said I would probably look for the inflation-adjusted variety or one with a fixed cost-of-living increase of 2-4% per year.
What about other types of annuities?
But what about the more sophisticated, “feature-rich” fixed-index and variable annuities? Could one of them be a better solution, perhaps by providing lifetime income along with some upside to help with inflation?
Both types of annuities sold like hotcakes in 2019. Insurance group studies projected that indexed annuity sales would increase by 38% over five years; variable annuity sales were expected to increase at a slower rate (10%).
The 2025 update: These projections proved accurate and then some. Recent data shows that through the third quarter of 2025, annuity issuers released 96 new FIA products—marking a 35% increase over 2024—with total sales exceeding $125.5 billion for the year. The wave of retiring baby boomers, combined with concerns about market volatility and rising longevity awareness, has fueled this growth.
Some reasons for this popularity include the increasing number of baby boomers reaching retirement age, distrust of stock market volatility, and rising concerns about longevity risk. I also think it has to do with the armies of insurance salespeople who are being incentivized by high sales commissions.
These annuities have traditionally had a pretty bad reputation, owing mainly to overzealous salespeople, the products’ inherent complexity, and sometimes high (and occasionally hidden) fees. Some of these criticisms were certainly warranted in the past, and may still be appropriate for certain products today.
FIAs are unique and sophisticated products that are not appropriate for everyone. To make matters worse, they are sometimes sold with misleading claims. For example, some product literature and earnest salespeople say things like: “Get stock market returns with no downside risk.” But as we shall see, these statements aren’t totally accurate.
The proposal that I looked at for my friend in 2019 was for a fixed index annuity (FIA). After reviewing it, my overall reaction was that it was not too bad; in fact, it was probably better than most. It seemed to offer a greater upside than most fixed-income investments (such as CDs and bonds), while also protecting principal.
I read that FIAs have gotten better (greater transparency, better rates, lower fees, etc.). So, for these reasons and others, I thought it would be prudent to take a fresh look. And because they are so popular, I decided to also do a deeper dive on variable annuities, which will be the third (and final) post in this series.
Understanding fixed index annuities
Fixed-index annuities (FIAs) can be challenging to understand. FIAs are a type of deferred-income annuity that is intended to help you grow your principal during an “accumulation period” until you start using it for retirement income (the “distribution period”).
This growth happens in a couple of ways. FIAs have a guaranteed minimum interest rate (typically 0-1%), but their overall performance is tied to a stock market index. The growth of your principal is based on the price of a selected stock market index, which can fluctuate (sometimes significantly) from year to year.
Although there are many index options to choose from, one of the most commonly used is the S&P 500. Other popular choices include the Nasdaq-100, Dow Jones Industrial Average, and increasingly, proprietary “volatility-controlled” or “hybrid” indexes designed by insurance companies in partnership with banks.
Critical understanding: The index you select is used by the insurance company as a stock price index, not as a total return index. The total return for the S&P 500 includes both dividends and capital gains. But your principal gains (or losses) will be calculated based only on the index’s price change over a specific period, not on total return.
This provision is important because, historically, S&P 500 dividends have averaged between 2-3%, and have at times been more than 4%. Since you don’t actually own a mutual fund that replicates the chosen index (such as Vanguard’s S&P 500 Index Fund—VFINX), you won’t directly receive those dividend payouts as income.
The price percentage changes to your chosen index, either up or down, are applied to your account by the insurance company using a formula to calculate the applicable percentage rate. The result is that you will not only not receive the total return (price appreciation plus dividends), but there will typically be a limit to how much your account will be credited.
How crediting works
Insurers use a variety of limiting factors:
Cap Rate: The maximum percentage your account can be credited in a given period, regardless of how well the index performs.
2019 example: My friend’s proposal had a 6.35% cap—pretty generous for that time when most were in the 4-5% range.
2025 update: Current FIA cap rates have improved significantly:
- Top-tier products now offer caps of 10.75-11% for 5-7 year terms
- Standard S&P 500-linked products typically offer 8-10% caps
- Some products offer caps as high as 11-12%, though these may not last
Participation Rate: The percentage of the index gain that will be credited to your account.
- Example: With a 75% participation rate, if the S&P 500 gains 20%, you’d be credited with 15%
Spread Rate (Margin): A percentage subtracted from the index gain before crediting.
- Example: With a 4% spread, if the index gains 10%, you’d be credited with 6%
By the way, although the formula used for the calculation doesn’t change, the limiting rate used for the index calculation may be changed by the insurance company on each contract term anniversary date. This is a crucial point—your initial attractive rate may not continue.
How it works in practice:
If the value of the S&P 500 at the end of the one-year indexed term is higher than at the beginning, your account would be credited with the percentage change, up to the cap (the “upside”).
If the difference is negative, then the account will be credited with 0% (little or no “downside”), so there is no loss, and all previous earnings remain intact. This is, in my opinion, one of the FIA’s most attractive features.
For example, with a 10% cap:
- If the S&P 500 gains 15%, you’re credited with 10%
- If the S&P 500 gains 6%, you’re credited with 6%
- If the S&P 500 loses 20%, you’re credited with 0% (no loss)
The 2025 FIA Landscape: What’s Changed
Positive developments:
- Higher caps: 10-11% vs. 5-6% in the 2010s low-rate environment
- More transparency: Better disclosure of fees and limitations
- New index options: Volatility-controlled indexes that may offer smoother returns
- Innovation: Products like “rate-for-term” designs that lock rates for the entire contract period
- Digital tools: Better calculators and illustration tools
Concerns that remain:
- Proprietary “hybrid” indexes: New engineered indexes with no performance history
- Complexity: Still difficult to understand all the moving parts
- Changeable terms: Caps and rates can be adjusted annually
- Hidden costs: Fees still embedded in the cap/spread structure
Taking income from an FIA
Because FIAs are most appropriately set up initially as deferred annuities, consumers elect to start withdrawals at a later date. For example, you might purchase one at age 55 and not begin withdrawals until age 70. Your principal would grow based on the crediting mechanism described earlier, or, at the very least, you would not lose money even if your chosen index has a net loss over the same period.
Liquidity concerns:
It would be a mistake to assume that you can withdraw your money at any time. FIA contract lengths vary anywhere from 5 to 10 years. The surrender charge—or penalty for early withdrawal—will vary with the length of the contract.
Typical surrender charges might look like this for a 7-year contract:
- Year 1: 9%
- Year 2: 8%
- Year 3: 7%
- Year 4: 6%
- Year 5: 5%
- Year 6: 3%
- Year 7: 0%
In other words, you would need to let the money “sit” for at least five to seven years before taking significant withdrawals without penalty—not a problem if you didn’t need it until later. But if you needed it for an emergency, it would cost you dearly.
Most FIAs allow penalty-free withdrawals of 10% of the account value annually, providing some liquidity.
Once you get beyond the “surrender penalty phase,” you can withdraw as much as you want whenever you want, similar to what you could do if you were drawing from an IRA.
With an FIA, no matter your withdrawal rate, you are guaranteed to receive back at least your original principal (minus any withdrawals). That is not the case with an immediate fixed-income annuity because you and your beneficiary could pass away before you reach your “break-even” point.
Income riders: the GLWB option
The other way to create an income stream would be to set up an “income for life” arrangement. This approach requires that you purchase an “income rider” (insurance-speak for “extra cost options”).
Buying a rider enables an FIA holder to receive a guaranteed monthly benefit, even if it exceeds the principal they originally contributed. Understandably, this is one of the FIA’s more attractive features.
Income riders come in different flavors, but most purchasers prefer the “Guaranteed Lifetime Withdrawal Benefit” (GLWB). These are common add-ons to both fixed-index and variable annuities because they solve the “guaranteed income for life” problem.
How GLWBs work:
- You build up a “benefit base” (often higher than your actual account value)
- After a deferral period, you can withdraw a percentage annually for life
- Typical payout rates: 5-10% of the benefit base, depending on your age
- The longer you wait to take income, the higher your payout rate
- Your beneficiaries can still inherit any remaining account value
But they do come at a cost: Typical GLWB rider fees range from 0.75% to 1.5% annually.
What about costs?
One of the big knocks against fixed-index annuities is cost. They have a reputation for fees and sales commission charges buried in them. By that, I mean that while the terms and fees should be fully disclosed in the product literature, they often are not and, therefore, can be hard to decipher.
The problem is that fees, no matter how they are assessed, reduce your returns. They are usually taken from future earnings, which is one of the main reasons most FIAs have earnings caps. With most FIAs, the company must make its money by investing your principal and via the cap/spread dynamic applied to index crediting. They calculate that, over the long run, they will earn more on your money than they credit to you.
Types of costs in FIAs:
- Embedded costs: Built into the cap/spread structure (not explicitly stated but real)
- Rider fees: 0.75-1.5% annually for income riders like GLWBs
- Surrender charges: Penalties for early withdrawal (declining over contract term)
- Administrative fees: Some products charge annual account fees ($25-50)
- Sales commissions: While not paid by you directly, they’re built into the product structure (typically 5-7%)
The FIA I looked at for my friend in 2019 had no stated base fees or up-front commissions in the product literature. That was a good thing because his principal wouldn’t be reduced from the start. However, that didn’t mean that there weren’t any. As with most FIAs, they were probably “baked in” to the index cap/spread/crediting dynamic.
2025 improvement: Commission-free FIAs are now available for fee-based advisors, offering greater transparency. Products like Nationwide and Midland National’s Capital Income Annuity represent this trend toward lower-cost structures.
Stock market returns, really?
Many FIAs are misrepresented as “investments” that can deliver stock market returns with no downside risk. But they are not investments—they are an insurance product with earnings tied to a stock market index. They do not deliver “stock market returns.” What they will do—and are contractually bound to do—is to provide reasonable returns in up-market conditions (but not actual market returns) while protecting principal during down-markets.
Whether this is good or bad depends on your individual needs and expectations. Over extended periods of market ups and downs, FIAs can be expected to deliver long-term CD or bond-like returns, perhaps a little better.
The models prepared for my friend by his advisor in 2019, which were based on real S&P performance during specific up and down periods, were a fair and reasonable characterization:
- “Very favorable” period (Dec 2008 to Dec 2018): 4.44% average annual gain
- “Very unfavorable” period (Dec 2000 to Dec 2008): 3.83% average annual gain
But there was a problem. What my friend was not shown by his advisor was a similar model of how he would have fared during those same periods if he had his money invested in an S&P 500 Index Fund, such as VFINX.
My analysis showed that he would have had average total returns (capital gains plus dividends) of:
- “Very favorable” period: 13.12%
- “Very unfavorable” period: 3.57%
Therefore, for the entire 20-year period, he would have been better off investing in an S&P 500 Index Fund, assuming he could have stayed on the market roller coaster and not panicked during downturns.
The real value proposition:
To be fair, in a worst-case scenario—several decades of net-negative S&P 500 returns—an FIA would be the better option since there would be no loss of principal. However, nothing like that has ever happened in the history of the U.S. stock market. The index has been down only 8 out of the last 30 years.
Could things be very different over the next 20 or 30 years? Indeed, they might, and if you believe they will be, then you may want to look somewhere other than the stock markets altogether.
What FIAs actually deliver: Think of FIAs as delivering returns somewhere between traditional fixed annuities/CDs and stock market investments—typically in the 3-6% average annual range over long periods, with protection against losses.
Would I buy an FIA, and should you?
My 2019 conclusion remained unchanged:
Overall, I think an FIA would be a reasonable choice for someone who:
- Doesn’t need access to their principal for at least 5-10 years and therefore would be a candidate for a deferred-income annuity
- Doesn’t want to be at all concerned about stock market volatility
- Will be happy with relatively low to mid-single-digit returns each year
- Values principal protection above growth potential
- Wants some market participation without direct market risk
Because I am retired and in the “distribution phase,” I would prefer not to lock up a significant part of my savings for the next 5-10 years as I need the income it generates now. And while I am concerned about market volatility, I am more interested in income from dividends and interest, which, though far from being immune from market conditions, are not directly tied to day-to-day market ups and downs.
I might be okay with low- to mid-single-digit returns, especially with no downside risk, but I would prefer to receive them as income while also having the potential for investment gains I could convert to income in the future.
The 2025 perspective:
The improved cap rates (now 10-11% vs. 5-6% in 2019) make FIAs more attractive than they were. However, my fundamental concerns remain:
- Complexity and lack of transparency in many products
- Loss of liquidity for 5-10 years
- Returns that lag the broader market in up years
- Inflation protection is still not guaranteed (fixed payouts lose purchasing power)
- Fees embedded in the structure
As with immediate-income annuities, I won’t say that I would never purchase one, but I think it is unlikely at this point in my life. If I decide that I need an annuity, I would probably lean toward some kind of inflation-adjusted immediate annuity as I discussed in my last article, or perhaps wait until I’m older (75-80) when immediate annuity payout rates are even more attractive.
Should you consider an FIA?
Whether an FIA makes sense for you totally depends on your situation. If you meet all of the criteria I mentioned above and are comfortable handing over a chunk of your savings to an insurance company, then give an FIA serious consideration.
But be sure to:
- Do your homework—understand all terms and conditions
- Know what is contractually guaranteed and what isn’t
- Read all the fine print, especially regarding how caps and rates can change
- Compare multiple products from multiple highly-rated companies
- Understand all fees, including embedded costs
- Be wary of proprietary “hybrid” indexes with no performance history
- Work with a financial representative you can trust to have your best interests at heart
Still standing pat—for now
Although I see some value in owning an annuity—and FIAs have improved significantly since 2019—I am going to stand pat with my income-oriented stock/bond portfolio for the time being. The improved cap rates make FIAs more competitive, but they still don’t solve the inflation problem that concerns me most.
If you are convinced that an annuity is the right thing for you, I would say “go for it”—just make sure you understand exactly what you are getting into. And even then, my suggestion would be to allocate no more than 30-40% of your retirement assets to one. That keeps other options open to you.
Having looked at immediate-income annuities and fixed index annuities, the third and final article in this series will be about variable annuities. As I stated previously, these are the ones I am least interested in, but as it turns out, they have historically been popular (though FIAs are now outselling them). On that basis alone, they warrant further treatment.