Indexed Annuities vs. Variable Annuities


byNikhil Bhauwala

Fri Mar 08 2024

Author @ AdvisorWorld.com Inc
Indexed vs Variable

An Overview of Annuities

Annuities, versatile financial instruments, serve as vehicles for long-term investment, catering to diverse retirement objectives. Characterized by tax-deferred growth and consistent income streams, annuities offer an array of choices, such as fixed, variable, and indexed variants, each carrying distinct risk profiles and return prospects. 

Fixed annuities, the least risky among the trio, guarantee a predetermined interest rate, insulating investors from market fluctuations. In contrast, variable annuities, tied to market performance, comprise diverse portfolios of stocks, bonds, and money market accounts. While these annuities present the potential for higher returns, they also harbor the risk of losses. Indexed annuities straddle the line between fixed and variable annuities, tethered to market indices like the S&P 500. While they offer minimum guaranteed interest rates, they cap the maximum annual interest, limiting potential returns.

What is an Indexed Annuity?

Indexed annuities pay a minimum interest rate at the time of signing. This rate is typically better than what you would receive with a fixed annuity. Additionally, with an indexed annuity, there is the potential for an added growth rate of return based on a specific market index. This makes it a more savvy investment than a fixed annuity. The index used could be the S & P 500 Index, the NASDAQ, or the Russell 2000, depending upon your annuity product. With an indexed annuity, when the market is good, you will see an income gain. Likewise, you will see a lower return when the market performs poorly. You should also note that some indexed annuities have a cap on the annual interest rate, which could limit your fund’s growth.

Should unexpected predicaments arise, necessitating urgent access to funds, it’s reassuring to have resources tucked away in your indexed annuity. Nevertheless, early withdrawal may incur steep surrender charges, emphasizing the importance of adhering to the account’s predetermined term. Finally, indexed annuities carry heftier fees and exhibit greater complexity compared to other annuities. As such, comprehending the annuity’s features and benefits is imperative before committing to an investment.

What is a Variable Annuity?

Variable annuities hinge on performance and encompass a diverse mix of stocks, bonds, and money market accounts. Similar to indexed annuities, the interest rate fluctuates in response to market shifts. Initiating a variable annuity requires a lump sum or agreement to make monthly installments. These annuities offer greater flexibility for withdrawals, suiting those anticipating early fund access. Additionally, you can designate a beneficiary to inherit your variable annuity upon your demise. Withdrawals can be made either in one go or over time.

Opting for a variable annuity entails higher fees, which could diminish your long-term investment capital. Besides market risk, imprudent management of a variable annuity carries the risk of outliving your investment.

Illustrative Examples of Indexed and Variable Annuities”

Indexed Annuity Example: Imagine investing $100,000 in an indexed annuity boasting a 2% minimum guaranteed interest rate, tethered to the S&P 500 index. Should the market flourish, you might enjoy an extra 5% return, culminating in a 7% total return. Alas, if the market falters, the 2% minimum guaranteed rate could be your sole return. Furthermore, certain indexed annuities might impose caps on maximum annual interest rates, such as 7%, potentially curbing your returns.

Variable Annuity Example: Envision investing $100,000 in a variable annuity comprising a blend of stocks, bonds, and money market accounts. A thriving market might bolster your investment’s value, yielding higher returns. Conversely, a struggling market may cause a decrease in value, leading to diminished returns or even losses. Also, variable annuities might carry heftier fees compared to other annuity types, like annual maintenance charges or withdrawal fees, which could eat into your overall returns.

Naturally, actual returns and risks associated with any annuity hinge on myriad factors, encompassing the specific product, market conditions, and individual investment objectives and risk tolerances. It’s crucial to meticulously examine the terms and conditions of any annuity before deciding to invest.

In Conclusion

When making plans for your investments, you should consider your personal retirement goals, how much you can invest, and how much of a risk you can tolerate. Next, review the costs and fees associated with the annuity and consult your accountant or attorney should the contract include clauses or phrases that you don’t understand.

Indexed and variable annuities are the most aggressive of their kind. They offer a good potential for growth with a slightly lower risk than stocks or other investments. With these annuities, you can enjoy a monthly, quarterly or annual payout that can help to pay bills or cover costs associated with retirement, home improvement or vacations.

©2024 AnnuityratesHQ. All rights reserved.