An index annuity is a variable annuity that claims to allow your funds to grow with the stock market while protecting you from losses. Like other annuity products they are heavily promoted by insurance salesmen, financial advisers, and others. They are usually costly to the investor compared to a mutual fund.
See the annuities article for details of their usual provisions. Like other variable annuities, index annuities can be annuitized usually after age 59-1/2 to make payments similar to pension payments usually for life.
In the accumlation stage, additional contributions can be made to the annuity while the invested funds are permitted to grow tax free. The value of index annuities is tied to a stock index, often the S&P 500 Index. That makes them seem like an S&P 500 Index fund of the kind often recommended to investors. Index annuities differ in that the gains are capped at a specified amount per year or quarter. Hence, in a good year, you can max out your gain while the market continues higher. Then in a bad year, you may not gain much.
Index annuities often offer protection from losses in a declining market. The protection takes the form of a guarantee that your account balance will be annuitized at no less than the amount you contributed, sometimes with some percentage escalator. However, the guaranteed floor usually does not come into play until you have lost all your gains.
As with other annuities, index annuities are designed with attractive features to make them easily sold. They are often complex products with numerous features, but few truely understand their features. Knowing what choices to make when can be important. A knowledgeable consultant who knows the products well is essential to getting the most from the contract. Too often, the salesman is eager to sell you a new annuity as soon as the surrender period on the first one expires.