By Ron Grensteiner, President of American Equity Investment Life Insurance Company

Often times we speak of annuities as though they are all the same products, equally appropriate for all consumers. This is particularly true when discussing index and variable annuities.  And it’s true that there are several benefits inherent across all annuities, which include—but are not limited to—the following:

• Earnings grow tax-deferred as long as you leave them in the annuity.
• The value built up during the accumulation period can be distributed in a lump sum payment or in income payments during the payout period.  For example, you might choose payments that continue as long as you live, as long as your spouse lives, or for a set number of years.
• Annuities provide guaranteed income.

However, when we look more closely at these two types of annuities, we find that there are some key differences between them that warrant clarification.  And, based on your financial needs and goals, as well as your tolerance of risk, you may be better served by one of these products than by the other.

To help clarify some of these key differences, let’s first start with an overview of each type of annuity and how they work.

Index Annuities – The Basics

An indexed annuity is a fixed annuity that earns interest based on an external index, usually a market index, such as the S&P 500.  The idea is to have the potential to earn more interest than a traditional fixed annuity, when the market index is positive, while not losing principle or interest when the market index is negative.  The insurance company also guarantees a minimum interest rate in fixed indexed annuities.

Here are some other important things to remember about how an index annuity works:

• When the index goes up, your interest earned is limited to a stated percentage or maximum cap of the increase.
• When the index goes down, your annuity value remains the same and you earn zero interest that year.
• The interest earned in the annuity can be calculated several different ways depending on the contract.

Variable Annuities – The Basics

During the accumulation period of a variable annuity, the insurance company puts your premiums (less any applicable charges) into a separate account.  You decide how the company will invest those premiums, depending on how much risk you want to take.  You may put your premium into a stock, bond, or other account. You receive all of the upside, and all of the downside for a possible loss.  You also have the option to put money into a fixed account which does provide a minimum guaranteed rate. During each pay out period of a variable annuity, the amount of each income payment to you may be fixed (set at the beginning) or variable (changing with the value of the investments in the separate account).  If you’d be more comfortable with an annuity that guarantees a minimum rate of return on all of the funds in your annuity, you may want to consider a traditional fixed annuity instead.

Overview of similarities and differences