Indexed Annuities

Indexed Annuities

If you want to limit potential losses while participating in the potentially attractive returns of a market-driven investment but would also like a guaranteed return, an indexed annuity might be worth checking out.

The performance of indexed annuities, also referred to as equity-indexed or fixed-indexed annuities, is tied to an index (for example, the Standard & Poor’s 500*). They provide investors with an opportunity to earn interest based on the performance of the index. If the index rises during a specified period in the accumulation phase, the investor participates in the gain. In the event that the market falls and the index posts a loss, the contract value is not affected. The annuity also has a guaranteed minimum rate of return, which is contingent on holding the indexed annuity until the end of the term.

The percentage of an index’s gain that investors receive is called the participation rate. The participation rate of an indexed annuity can be anywhere from 50% to 90% or more. A participation rate of 80%, for example, and a 10% gain by the index would result in an 8% gain by the investor.

Some indexed annuities have a cap rate. The maximum rate of interest the annuity will earn, which could potentially lower an investor’s gain.

Indexing formula

Several formulas are used to calculate the earnings generated by an indexed annuity. These indexing methods can also have an effect on the final return of the annuity. On preset dates, the annuity holder is credited with a percentage of the performance of the index based on one of these formulas.

Annual reset (or ratchet): Based on any increase in index value from the beginning to the end of the year.

Point-to-point: Based on any increase in index value from the beginning to the end of the contract term.

High-water mark: Based on any increase in index value from the index level at the beginning of the contract term to the highest index value at various points during the contract term (often anniversaries of the purchase date).