Fixed Indexed vs. Variable Annuity: the only chart that matters.
Most retirees don't know there are five different kinds of annuities. Only one of them is what I actually recommend, and once you see the difference on a single chart, you'll understand why.
The word "annuity" gets thrown around like it means one thing. It doesn't. Walk into three different offices and you'll hear three different products called by the same name, and two of them may be completely wrong for you. So before we compare anything, let's clear up what we're actually talking about.
An annuity is simply a contract with an insurance company. You give them money, and in exchange they promise you something back: growth, income, protection, or some mix of the three. The differences live in how they grow your money and who carries the risk. That's the whole ballgame.
The five kinds, in one breath
There are five annuity types you'll run into. Here they are in plain English:
- Fixed annuity. A flat, guaranteed interest rate, like a CD from an insurance company. Safe, simple, and usually modest.
- Multi-year guaranteed annuity (MYGA). A fixed annuity with a locked rate for a set number of years.
- Fixed indexed annuity (FIA). Your principal is protected from market loss, and your growth is linked to a market index up to a cap or participation rate. You never lose money to a down market.
- Variable annuity (VA). Your money is invested directly in market subaccounts. Bigger upside, but your account value can drop when the market drops.
- Immediate annuity (SPIA). You hand over a lump sum and income starts right away, usually for life.
For a retiree whose number one job is protecting the savings they spent 40 years building, the real decision almost always comes down to two of these: the fixed indexed annuity and the variable annuity. They sound similar. They are not.
The only chart that matters
Here is the side-by-side I draw on a napkin at nearly every kitchen table. If you remember nothing else from this article, remember this table.
| What happens to your money | Fixed Indexed (FIA) | Variable (VA) |
|---|---|---|
| Market goes up | You share in the gains, up to a cap or rate | You get most of the gains |
| Market drops 30% | You lose 0% | You can lose 30% |
| Who carries market risk | The insurance company | You do |
| Ongoing investment fees | Typically none inside the contract | Often 2%–4% per year, all-in |
| Principal protection | Yes, guaranteed* | No |
| Guaranteed lifetime income option | Yes | Sometimes, for an extra rider fee |
| Best suited for | Protecting savings and creating income | Growth, if you can stomach the swings |
*Guarantees are backed by the claims-paying ability of the issuing insurance company, not by the FDIC.
Where the variable annuity earns its bad reputation
Variable annuities aren't evil. In the right hands, for a younger investor with a long runway and an appetite for risk, they can make sense. But they get sold to the wrong people constantly, and here's why retirees get burned:
The fees stack. A typical variable annuity carries a mortality and expense charge, subaccount management fees, and often an income rider fee on top. Add them up and you can be paying 3% or more every year before you earn a dime. In a flat market, those fees quietly eat your account.
The losses are real. Because your money sits in market subaccounts, a bad year is a bad year. Retirees who bought variable annuities in 2007 watched their "retirement product" fall right alongside their 401(k) in 2008. That is the exact opposite of what most people wanted when they bought it.
Where the fixed indexed annuity fits
An FIA is built for a different job. It is not trying to beat the S&P 500. It is trying to make sure a bad decade doesn't decide when you can retire or how long your money lasts.
Here's the tradeoff, stated honestly: in exchange for never losing principal to the market, you give up some of the upside in the very best years. If the index returns 25%, you might earn 8% to 10% because of a cap. If the index returns -30%, you earn 0%, which beats -30% every single time. Over a full market cycle, that "lose nothing in the down years" floor does a lot of quiet work.
Layer on an optional income rider and the FIA can also hand you a paycheck you cannot outlive, one that keeps coming for you and your spouse whether the market is up, down, or upside down. For a retiree, that combination of protected principal and predictable income is usually worth far more than a shot at the market's very best year.
So which one is right for you?
Ask yourself one question: what is this money's job?
If its job is aggressive growth and you have decades ahead of you and the stomach to ride out crashes, a low-cost investment account usually beats any variable annuity, and I'll tell you that to your face. If its job is to protect what you've built and turn it into income you can't outlive, the fixed indexed annuity is almost always the better tool.
Most retirees I sit with fall into the second group. They've already done the hard part. They saved. Now they want to keep it, and sleep at night. That's exactly what an FIA is designed to do.
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