Last year, I watched my brother-in-law lose about $34,000 in three months.
He had his retirement savings in a mutual fund tied to the S&P 500. Not a bad strategy generally except the market dropped nearly 22% between August and October and he was 61 years old with no income rider, no floor and no plan B. He didn’t sell. But he also didn’t sleep well for about four months.
I’d moved a chunk of my own money into an index annuity about eight months before that. Watching what happened to him and watching what didn’t happen to me was the clearest real-world explanation of what this product actually does that I’ve come across.
Here’s what that period looked like from my end.
What an Index Annuity Actually Does When the Market Falls
When people ask about index annuities, the explanation usually goes: you get the market upside with a floor that protects you from losses. Which is accurate but kind of abstract until you see it play out.
Here’s the concrete version. My index annuity uses a one-year point-to-point crediting strategy linked to the S&P 500. At the end of each contract year, the carrier looks at where the index started and where it ended. If it’s up, I get credited a percentage of that gain up to my cap, which was 11.5% when I signed. If it’s down any amount, including 20% I get credited zero.
Not negative. Zero.
My account value on the day the market dropped 20% in that index period: unchanged.
My brother-in-law’s account on that same day: down $34,000.
That difference is the whole product in one sentence.
The Trade-Off Is Real and Worth Understanding
An index annuity isn’t the same as being invested in the index. Let me be clear about that, because some people find this out later and feel misled.
When the S&P runs up 24% in a year and your cap is 11.5%, you earn 11.5%. The carrier keeps the rest. That’s how they fund the floor guarantee, they’re essentially buying options on the index and passing a portion of the gains to you while absorbing the downside risk themselves.
So in a strong bull market, a straight index fund will beat an index annuity. That’s not a flaw in the product; it’s the design. You’re trading uncapped upside for a guaranteed floor and depending on where you are in your retirement timeline, that trade can be a very reasonable one.
My brother-in-law, at 61, probably shouldn’t have been in a position where a 20% market drop cost him five years of careful saving. I’m 58. I thought about his situation and decided I didn’t want to find out what a bad sequence of returns does to a retirement that starts in the wrong year.
What the Numbers Look Like Over Time
I’ve had my index annuity for a little over two years. In the first contract year, the index was up about 18%. I was credited 11.5% (my cap). In the second year, the index dropped 19%. I was credited 0%.
Net result across two years: 11.5% growth on my principal. No losses.
If I’d been in a straight S&P index fund those same two years, the math would be roughly: up 18%, then down 19% which lands you at a net loss relative to where you started, because percentage losses eat more than equal-sized percentage gains.
That’s not a sales pitch. That’s just how math works in volatile periods. Flat is better than negative when you’re in the years right before or right after retirement.
The Part Nobody Explains Until You Ask
What I didn’t fully understand when I first started researching index annuities was that the floor and the cap aren’t the only levers. There’s also the credit method point-to-point, monthly average, daily average each of which produces different results in different market conditions.
Point-to-point is straightforward and usually the highest cap. Monthly average smooths out volatility but can underperform in a market that drops early and recovers late. The advisor I worked with (found through a retirement matching service, which I’d recommend to anyone who doesn’t want to cold-call insurance companies) explained that most people with a five-plus year horizon do fine with point-to-point, because what you’re really protecting against is the single bad year that wipes out several good ones.
That’s the scenario I was trying to avoid. It’s also, roughly, what happened to markets twice in the last five years.
Final Thoughts
A 20% drop in the S&P doesn’t mean the same thing to every retiree. If you’re 45 and fully employed, it’s a buying opportunity. If you’re 60 with a fixed retirement date, it might mean delaying that date by two years.
An index annuity doesn’t solve every problem. It doesn’t offer the kind of growth that a good equity portfolio can produce over 20 or 30 years. But it does one specific thing very well: it removes the floor from beneath your retirement savings, so that one bad year or one bad sequence of years doesn’t redefine your retirement on the way in.
My brother-in-law recovered. The market came back and so did his account. But those four months cost him sleep, confidence, and about $8,000 in panic-sale decisions he made before stopping himself. I didn’t have any of that. And right now, in the years leading up to when I’ll actually need this money, “nothing happened” is exactly the outcome I was paying for.
