Indexed annuity.

In plain English

An indexed annuity (sometimes called a fixed indexed annuity) credits interest based on the performance of a market index, but you do not actually own the stocks. The insurer protects you from losses with a floor, usually zero, so a down year does not shrink your principal. In exchange, your gains are limited by a cap, a participation rate, or a spread, so you capture only part of a strong year. The details of those limiting features are the whole story, and the insurer can often change them after the first year.

01Why it matters

The pitch of market upside with downside protection sounds ideal, but caps and participation rates can keep your real returns modest, so you need to read exactly how gains are credited before locking money in.

02The math, step by step

Suppose an indexed annuity has a floor of 0 percent and, in this example, a cap of 6 percent (the actual cap is set by the insurer and can change each year). If the linked index rises 15 percent that year, you receive only up to the cap. If the index falls 15 percent, you lose nothing because the floor holds your balance steady, but you also earn nothing that year.

Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.

03What this is NOT