Investing Assets & Markets Annuities Indexed Annuities: The Good, the Bad, and the Truth By Stan Garrison Haithcock Stan Garrison Haithcock Website Stan Haithcock is a national annuity expert who serves as a consumer advocate on annuities. He has more than 25 years of experience in the financial services industry, with many of them spent as an investment advisor on Wall Street. Currently, Stan educates consumers about annuities through his platform, "Stan The Annuity Man." He has written several annuity owner's manuals, as well as a book, "The Annuity Stanifesto." learn about our editorial policies Updated on October 28, 2021 Reviewed by David Kindness Photo: John Lund / Getty Images Annuities are financial products offered by insurers. They can provide you with an income stream that you can't outlive. Since many firms these days no longer offer pensions, annuities have become a solid option to round out your financial plan. The only issue you may have with one is wading through the many types offered and finding the best one for you. An indexed annuity is one popular option, but you should review the terms before buying one. Key Takeaways Insurers offer annuities as part of their financial product lineup. They can provide you with an income stream that will last throughout your life.Many indexed annuities have a minimum interest guarantee. Your money is safe from market ups and downs.Indexed annuities have a history of being oversimplified by the agents selling the products. Still, they are complicated.Indexed annuities are good if you keep your expectations realistic. Indexed Annuities: The Good Indexed annuities have a few things in common with fixed and variable annuities. Many indexed annuities have a minimum interest guarantee. This means that the original amount you put into the plan is safe from market volatility. This is in line with what more retired people have started to require. Indexed annuity returns are based on an index like the S&P 500. If the value of the index goes up, you receive a return based on that value. If the value of the index goes down, you receive a guaranteed minimum interest rate. The upside is limited, but the gains are locked in on the contract anniversary date. That's the value proposition for these annuities. Note According to the SEC, some indexed annuities don't have a guaranteed interest rate. It's vital that you look at potential annuities with care to ensure you know the terms and risks. If you feel good about CD-type returns, then indexed annuities could work well in the principal-protected part of your portfolio. To be clear, it is a contractual fact that an indexed annuity is not meant to take the risks or reap the highest rewards of the stock market. You don't receive dividends, and your participation rate limits your gains. Your participation rate means you receive credit for a portion of the index's growth. If you have a 75% participation rate and the index grows by 7%, your annuity will be credited 5.25% interest (7% × 75%). On the plus side, if the index drops by 5%, you may still receive the minimum guaranteed interest rate. The amount you receive if the index drops will depend on the terms of your contract. Indexed Annuities: The Bad Some agents selling indexed annuities may simplify what they are and how they work. The truth is that these annuities are complex. This doesn't mean that they're bad. Still, it does mean that you should take the time you need to review any annuity you want to buy. If you have a trusted financial advisor, consult them before buying an indexed annuity. You should also know who is regulating the annuity. This depends on whether or not the annuity is a security. If it is, the SEC will monitor it. If it's not, it's regulated by your state's insurance laws. Indexed annuity complaints should be made to the correct regulatory group. It's also vital to know that you can lose money in an indexed annuity, even one with a minimum interest rate guarantee. This can happen if you withdraw money from your annuity early or if you surrender the annuity too soon. Early would be before you turn 59 1/2. If you withdraw money too early, you may be charged a tax penalty. If you surrender the annuity too soon, you may have to pay charges for that as well. The contract will spell this out. In some cases, you may be have a tax penalty and surrender charges. A good rule of thumb is to only put money into an annuity that you don't expect to use any time soon. Indexed Annuities: The Truth Indexed annuities were first created to compete head-to-head with certificate of deposit (CD) returns, not the stock market. In other words, they weren't designed to earn a lot of interest. Instead, they were created to earn a modest amount of interest that you can turn into a guaranteed income in the future. You can also add an income rider to an indexed annuity for future income guarantees. In fact, this may be the best way to use them. In most cases, you won't even look at the interest being earned. Focus on the income guarantees in your income rider. You should always own annuities for what they will do for you, rather than what they might do. The contract keeps your money safe. You could also use indexed annuities along with fixed-rate annuities for laddering strategies. Some call this a "mixed-fixed ladder" because it combines fixed-rate and indexed annuities. The bottom line is that indexed annuities are not too good to be true. They can be pretty good if you keep your expectations in line with the details of the contract. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. NAIC. "Buyer's Guide to Fixed Deferred Annuities With Appendix for Equity-Indexed Annuities," Page 2. FINRA. "Indexed Annuities." NAIC. "Buyer's Guide to Fixed Deferred Annuities With Appendix for Equity-Indexed Annuities," Page 15. FINRA. "Equity-Indexed Annuities: A Complex Choice." Investor.gov. "Investor Bulletin: Indexed Annuities." Investor.gov. "Annuities."