Indexed annuity vs. fixed annuity: Definition, differences, and pros and cons

If you’re looking to get more out of your savings, indexed and fixed annuities are two options worth exploring. These financial products help you save for the future — securely. Both choices have distinct advantages, and understanding how they work can make planning for your unique needs easier.

Learn how indexed annuities differ from fixed annuities and discover which option may best suit your circumstances.

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What’s an indexed annuity?

An indexed annuity (or fixed index annuity) is a safe option for growing your savings and earning more than with a traditional savings account — all with protection from market fluctuations. Your insurance company calculates your returns using a formula that’s tied to a stock market index like the S&P 500^®. Funds remain in an account with the insurance company, who manages your deposit. 

Your insurer uses financial methods like buying options on the market index to help you earn returns based on index performance. If the market goes up, you earn interest. But if it goes down, your money is protected, and you won’t lose your initial deposit.

Fixed index annuities are not securities and do not participate directly in the stock market or any index and are not investments. It is not possible to invest directly in an index.

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What’s a fixed annuity?

Fixed annuities (which differ from fixed index annuities) let you save money and grow it over time while guaranteeing you’ll receive regular payments later — typically during retirement.

When you buy a fixed annuity, you agree to deposit funds, either all at once or over time. Your insurer agrees to pay you a guaranteed interest rate on your savings, letting your money grow steadily, regardless of stock market performance.

During the accumulation phase, your money earns interest at the agreed-upon rate. Later, in the payout phase, your insurer can pay you back in regular payments for a set number of years or for life, depending on the contract. 

Fixed annuities are a low-risk way to save because your deposit remains protected, and you know approximately how much your money will grow. However, these plans usually don’t earn as much as other financial products like stocks and variable annuities.

Compound interest helps your fixed annuity money grow. The insurance company can add interest to your account, which then starts earning its own interest. Over time, this interest-on-interest setup drives faster growth, even if you don’t add anything more to the account.

Here’s a simple hypothetical example of an indexed versus fixed annuity:

• Fixed annuity: You contribute $50,000 in a fixed annuity that offers a guaranteed 5% annual return. Every year, you’ll earn $2,500 (5% of $50,000) no matter what happens in the stock market. This method is stable and predictable.
• Indexed annuity: You contribute $50,000 in an indexed annuity linked to the S&P 500^® with a 6% cap and an 80% participation rate. If the S&P 500^® increases by 10% in a year, your return is capped at 6%, and you’ll receive 80% of that cap — or 4.8% (so $2,400). And if the market declines, you won’t lose money but may not earn anything that year.

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5 differences between fixed and indexed annuities

Fixed and indexed annuities both grow savings and provide income, but they work in distinct ways. Here’s how they differ in five fundamental categories.

1. Interest rate

‍Fixed annuities: A fixed interest rate for a set time ensures steady growth.

‍Indexed annuities: The insurance company calculates your returns based on how a stock market index performs. Your money doesn’t go directly into the market, but your earnings are tied to its movements, allowing growth while keeping your principal safe.

2. Earnings potential

‍Fixed annuities: These have lower earning potential because their returns are fixed and don’t depend on stock market performance.

‍Indexed annuities: When the market performs well, individuals can achieve higher earning potential, though insurers often cap gains.

3. Risk

‍Fixed annuities: Your deposit and interest are guaranteed, meaning there’s little risk involved.

‍Indexed annuities: Risk is slightly higher due to reliance on market performance, but your deposit is still protected.

4. Costs

‍Fixed annuities: Typically, you won't encounter extra fees beyond surrender charges when you withdraw funds early. 

‍Indexed annuities: You may face higher administrative, maintenance, and commission fees than with fixed annuities — although modern insurers like Gainbridge^® remove the middleman, so you avoid paying these fees. 

5. Growth mechanism

‍Fixed annuities: Growth is steady and not influenced by external factors.

‍Indexed annuities: Growth varies and is influenced by market performance, with a guaranteed minimum.

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Indexed vs. fixed annuities: Pros and cons

Here’s a breakdown of the advantages and drawbacks of each annuity type so you can determine which may work best for your long-term financial goals.

Fixed annuities

Pros

• Guaranteed growth: Your money grows at a fixed rate, so you know exactly how much you’ll earn.
• Low risk: There’s no exposure to market ups and downs, so your principal and interest are safe.
• Manageable to understand: Fixed annuities are relatively easy to manage.

Cons

• Lower growth potential: Returns are limited to the fixed interest rate, which may not keep up with inflation.
• No market upside: You won’t benefit from stock market gains.

Indexed annuities

Pros

• Growth potential: Your earnings are tied to a market index, so you benefit from market gains.
• Principal protection: Even if the market drops, you won’t lose your initial contribution.
• Tax-deferred growth: Your earnings aren’t taxed until you start withdrawing funds.

Cons

• Capped gains: There’s a limit on how much you can earn, even if the market performs well.
• Complexity: These products have more rules and terms, which can be confusing.

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Choosing your annuity type

The best choice between a fixed and an indexed annuity depends on your financial situation, risk tolerance, and long-term goals. Fixed annuities offer stable and predictable growth, while indexed annuities offer market-based earnings — with some loss protection.

Fixed annuities may be best for:

• Individuals who want guaranteed, steady growth without market risk
• Retirees looking for consistent income and financial security
• Those who prefer simplicity and straightforward interest options

Indexed annuities may be best for:

• People who want to earn from the market without risking their initial contribution
• Those seeking higher growth potential than fixed annuities can provide
• Those comfortable with more complex financial products in exchange for better earning opportunities