The Truth About Annuities and Market Growth

What Does “Growth” Actually Mean in an Annuity?

When people talk about annuities and growth, very different financial products often get lumped together. That’s where much of the confusion begins.

A fixed annuity doesn’t pursue growth the same way a fixed indexed annuity does. A fixed indexed annuity doesn’t work like a variable annuity. And a registered index-linked annuity can have a different risk-and-return structure from all three.

So asking whether “annuities grow” without identifying the type is a little like asking how fast “vehicles” travel without specifying whether you’re talking about a bicycle, a car or an airplane. The mechanism matters.

Fixed Annuities: Growth Without an Index

A traditional fixed annuity can credit interest according to the terms of the contract without tying the owner’s return directly to stock-market performance. The insurer declares the interest rate that applies, and many contracts also specify a guaranteed minimum rate for the periods in which one applies.

Multi-year guaranteed annuities take that idea further by specifying a rate for a stated number of years. In every case, the guarantees behind the contract are obligations of the issuing insurance company and are subject to its financial strength and claims-paying ability.

There is a trade-off, though, and it deserves to be said plainly: a declared fixed rate may not provide the same upside potential as market investments. Over a long retirement, inflation and purchasing power are real considerations when a portion of savings is positioned primarily for stability.

Fixed Indexed Annuities: Linked to an Index, Not Invested in It

A fixed indexed annuity may use the performance of an external index — often a broad stock-market index — as part of the formula used to determine credited interest. That connection is where much of the confusion in this category comes from.

The contract owner is generally not directly investing in the index. The index serves as a reference point in a crediting formula, not as a portfolio the owner holds.

How much interest is actually credited can depend on the crediting method and terms that apply to the strategy selected — which may include caps, participation rates, spreads, crediting periods, the particular index strategy chosen and other contractual provisions.

A Rising Index Doesn’t Mean You Receive the Full Index Return

A simplified example makes the mechanics easier to see. Suppose a referenced index rises 10% during a measurement period, and a hypothetical contract applies a 6% cap to the strategy selected for that period. In that simplified example, the credited interest would be limited to 6% rather than 10%.

A participation rate works differently. If the same 10% index movement were instead subject to a hypothetical 50% participation rate with no cap, the calculation in that simplified example would produce 5% of credited interest (10% × 50%).

Actual contracts can use different crediting methods, may combine them, and may apply different terms to different index strategies. Certain terms can also change over time subject to the provisions of the contract, which is why understanding the methodology matters more than any single number.

What Happens When the Index Falls?

With a traditional fixed indexed annuity, a decline in the referenced index does not generally result in the contract owner being credited that same negative index return — subject to the actual terms of the contract. This is the feature many consumers have in mind when they describe these products as protective.

Precision matters here, because contract value can still be affected by things unrelated to index performance.

RILAs: More Growth Potential Can Come With More Risk

Registered index-linked annuities belong in a category of their own. A RILA can provide index-linked return potential while also exposing the owner to a defined amount of market loss, depending on how the contract is structured.

At a high educational level, some RILAs use a buffer, where the insurer absorbs index losses up to a stated amount and the owner bears losses beyond it. Others use a floor, where owner losses are limited to a stated maximum. Both structures mean the contract value can decline from index performance.

Variable Annuities: Investment Performance Matters Directly

In a variable annuity, contract value can be allocated among the investment options — often called subaccounts — available within the contract. Value can rise or fall based on how those investments perform.

That makes variable annuities fundamentally different from traditional fixed and fixed indexed annuities in terms of investment risk. The owner carries direct investment risk inside the contract.

• Investment risk: contract value can decline, including a loss of the amount invested.
• Upside potential: returns are tied to the performance of the investment options selected.
• Investment expenses: underlying fund expenses and contract-level charges may apply.
• Insurance features: the contract may include death-benefit or other insurance elements.
• Optional benefits: certain guarantees may be available for an additional charge, subject to their terms.

Variable annuities are securities. The prospectus is the document that describes investment options, risks, expenses and available benefits, and it should be reviewed before investing.

Protection and Growth Involve Trade-Offs

Most consumers, understandably, would like more upside, more protection, more liquidity, stronger guarantees and lower cost — all at the same time. Financial products don’t work that way.

An annuity offering contractual protection may not provide the same upside profile as investing directly in the market. A product offering greater market participation may expose the owner to greater risk. And a guarantee may come with limitations, costs or liquidity considerations attached to it.

“Annuity Growth” Isn’t One Thing

Some annuities provide fixed interest. Some calculate interest using the performance of an external index. Some provide index-linked upside while exposing owners to defined losses. Others allow investment through underlying investment options and can rise or fall with those investments.

That’s why blanket statements about “annuity returns” can be misleading in either direction. Before evaluating an annuity’s growth potential, first understand what type of annuity you’re looking at and how its growth mechanism actually works.

This article is general educational information and is not investment, tax or legal advice, nor a recommendation of any product or strategy. Annuity crediting methods, caps, participation rates, spreads, index strategies, charges, surrender schedules, riders and other provisions vary by carrier, product, contract and state, and certain terms may change subject to contractual provisions. Index performance does not equal credited interest, and fixed indexed annuity owners are not directly invested in any index. Insurance guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company. Variable annuities and registered index-linked annuities are securities and involve risk, including possible loss of value; read the prospectus and applicable disclosures before investing. Past index or investment performance does not predict future results. Consult appropriately licensed professionals regarding your individual situation.