If your annuity’s interest rate is tied to the value of a stock or other equity index, it is appropriately called an equity-indexed annuity. You’re probably already familiar with one of the most commonly used indices, the S&P 500. These special annuities can be valuable asset investment and allocation tools when used properly. This brief crash course on how your particular annuity can help you financially will clarify the ins and outs of how to receive the maximum amount of return on your capital.
Basics Of Equity-Indexed Annuities
Equity indexed-annuities, also simply known as index annuities are tax-deferred annuities whose credited interest is typically linked to the S&P 500 or international index. With guaranteed minimum interest rates usually ranging from 1% to 3%, you are protected from a loss of principal as long as you do not surrender your annuity prior to that term’s completion. In order to get the combination of features you desire, you may have to make a trade off, as different types of index annuity have different indexing methods.
Common Indexing Methods
Index linked interest is determined using a variety of different methods. “Racheting,” or annual reset indexing, compares index values at the beginning and end of the contract year, and adds interest during each year of the term. Point to point indexing is based on the difference between index values at the beginning an end of the term. The high water mark method bases interest on the difference between the highest index value during a term, and the initial value for the term. Point to point and high water mark indexing method annuities both add interest at the completion of the term, which means you may not get your interest for some time. Along with the participation rate, the indexing method has the greatest effect on the magnitude of interest you will receive.
Participation Rate
This factor determines just how much of the index increase will be used to calculate your interest, usually as a fixed percentage. Participation rates for newly issued annuities can vary daily, and many are guaranteed to be fixed for a specified period, generally ranging in length from a year to your entire term. This does not override the cap on interest that many companies attach to their annuities.
Advantages, Disadvantages and Tips
Other features, like index averaging, protect you from buying your equity-indexed annuity at a high point when averaging is done at the beginning of a term and safeguards against drastic index declines when computed at the end of a term. Like other options, this is a double-edged sword, as it can decrease how much interest you earn when the index rises near either end of the term.
Making sure that your annuity has the features that work best for you is the key to making money with your assets, and keeping the unpredictable flexibility of such market indexes in mind can help you avoid unpleasant surprises. Checking around online for the best set of overall annuity specifics is the only way to guarantee that your money is working for you even when you aren’t watching it.
See Also
- Immediate Annuities Explained
- Variable Annuities Explained
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