What is a fixed index annuity? How principal-protected annuities work

A fixed index annuity, also called a fixed indexed annuity, is a contract you buy from an insurance company. It credits you interest based on part of a market index's gain over a set term, usually a year. Say the index goes down over that term. The NAIC buyer's guide says zero interest is added, and your value won't go down as long as you don't withdraw.

You never own the index, so you also don't get all of its gains. Caps, participation rates and spreads limit what you're credited, and dividends are usually left out. The SEC notes the insurer can often change those terms over time.

A MYGA is simpler. It pays you a fixed interest rate that the insurer guarantees for the full term, much like a CD from an insurance company.

Each option protects you from a different risk. None protects you against everything.

Yes, you can, in a few ways. Regulators are clear on this, and so are we.

• Surrender charges: the free amount is often up to 10% a year. If you take out more during the surrender period, you pay a percentage of what you take.
• Market value adjustment: some contracts adjust your value up or down on early withdrawals, based on interest rates.
• Rider fees: the cost of an income rider or other add-on can come out of your account value. That can lower your value in a year with 0% credit.
• Inflation: your fixed rate or capped return may not keep up with rising prices.
• Insurer failure: your guarantees are only as strong as the company. State guaranty associations cover a limited amount.

You may plan to convert a slice of your IRA each year for several years. If so, the money still waiting can fall when the market drops. A protected annuity keeps that money from shrinking. Either way, a market drop after you convert won't change the tax you already owe.

An annuity inside your IRA or Roth adds no extra tax deferral. So its value to you has to come from protection, a fixed rate or lifetime income. See Roth conversion with an FIA for how yearly conversions are set up. See Lowering tax on your RMDs for why the years before RMDs are often your best window.

Much of the criticism you'll see online is aimed at complex, high-fee products sold hard to people who didn't need them. If you fear being sold something like that, your caution is fair. FINRA calls annuities complex and possibly costly. Agents are usually paid a commission by the insurer.

A plain MYGA or a simple FIA held for its full term is a different case. It may suit money you won't touch for years and can't afford to see drop. You give up some upside and some access, in return for no market loss. The key is knowing which product you're being shown and what it costs you.

These products are built for a narrow job. Skip them if any of these describe you.

• You need the money, or might, before the surrender period ends.
• You don't yet have an emergency fund in a bank account you can reach any day.
• You have a long time horizon and can ride out stock market drops for the growth.
• A CD or Treasury pays a similar rate for a shorter lock-up and is all you need.
• Your pension and Social Security already cover your spending, and you mainly want growth for heirs.
• You'd be swapping your annuity while it is still in its surrender period. That can start a new surrender clock.