FAQs- Indexed Annuities

Q: What is an Indexed Annuity?

A: An equity indexed annuity is a special type of contract between you and an insurance company. During the accumulation period – when you make either a lump sum payment or a series of payments – the insurance company credits you with a return that is based on changes in an equity index, such as the S&P 500 Composite Stock Price Index.

The insurance company typically guarantees a minimum return. Guaranteed minimum return rates vary. After the accumulation period, the insurance company will make periodic payments to you under the terms of your contract, unless you choose to receive your contract value in a lump sum.

Q: How are they different from other fixed annuities?

A: An indexed annuity is different from other fixed annuities because of the way it credits interest to your annuity’s value. Most fixed annuities only credit interest calculated at a rate set in the contract. Indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get and when you get it depends on the features of your particular annuity.

Your indexed annuity, like other fixed annuities, also promises to pay a minimum interest rate. The rate that will be applied will not be less than this minimum guaranteed rate even if the index-linked interest rate is lower. The value of your annuity also will not drop below a guaranteed minimum.

For example, many single premium annuity contracts guarantee the minimum value will never be less than 87.5% of the premium paid, plus at least 3% in annual interest (less any partial withdrawals). The insurance company will adjust the value of the annuity at the end of each term to reflect any index increases.

Q: What are some of the contract features?

A: Indexed annuities contain several features that can affect your return. You should fully understand how an indexed annuity computes its index-linked interest rate before you buy. An insurance company may credit you with a lower return than the actual index’s gain.

Some common features used to compute an equity indexed annuity’s interest rate include:

Participation Rates: The participation rate determines how much of the index’s increase will be used to compute the index-linked interest rate. For example, if the participation rate is 80% and the index increases 9%, the return credited to the annuity would be 7.2% (9% x 80% = 7.2%).  We guarantee a 100% participation rate with the indexed annuities.

Interest Rate Caps: Some equity indexed annuities set a maximum rate of interest that the equity indexed annuity can earn. If a contract has an upper limit, or cap, of 7% and the index linked to the annuity gained 7.2%, only 7% would be credited to the annuity. Margin/Spread/Administrative Fee: The index-linked interest for some annuities is determined by subtracting a percentage from any gain in the index. This fee is sometimes called the ‘margin,’ ’spread,’ or ‘administrative fee.’ In the case of an annuity with a ’spread’ of 3%, if the index gained 9%, the return credited to the annuity would be 6% (9% – 3% = 6%).

Another feature that can have a dramatic impact on the indexed annuity’s return is its indexing method (or how the amount of change in the relevant index is determined). Some common indexing methods include:

Annual Reset (or Ratchet): This method credits index-linked interest based on any increase in index value from the beginning to the end of the year.

Point-to-Point: This method credits index-linked interest based on any increase in index value from the beginning to the end of the contracts term.

High Water Mark: This method credits index-linked interest based on any increase in index value from the index level at the beginning of the contracts term to the highest index value at various points during the contract’s term, often annual anniversaries of when you purchased the annuity.

Q: What is the annuity’s term?

A: In general, indexed annuities (and other annuities, for that matter) require tying up your money for anywhere from five to fifteen years. Like any stock market investment, however, the shorter the term, the greater your risk that the market won’t perform well over the holding period.

Q: What exactly do you earn when the market goes up?

A: Indexed annuities credit you with anywhere from 50 to 100 percent of the price gain of the market – excluding dividends. Since you’re not earning dividends, you won’t earn as much as you might by investing directly in the market. The percentage rate you earn (called the participation rate) may change from year to year.

Q: At the end of the term, how does the company calculate your gain?

A: There are several methods of indexing gains. Some indexed annuities use the market price on the day your annuity matures. Others look at the market price on each policy anniversary and pick the highest one. Some policies credit you with a portion of each year’s market gains – if there are any. Others simply average the gains.

Q: Are there any limits to how much you can earn?

A: Sometimes, indexed annuities put a cap on how much you can earn during the year.

Q: What happens if the stock prices decline?

A: This depends on how your annuity is indexed. In general, if the stock market goes down, you do not earn as much or maybe nothing at all. However, the good news is, the main purpose of an Indexed Annuity is to protect your capital.

Q: What happens if you want to quit the annuity early?

A: Some policies will give you the guaranteed minimum return, while others will credit you with all or even part of your earnings, minus whatever surrender fee was established when you bought the policy. Getting out early may mean taking a loss.

Q: What if everything crashes?

A: Indexed annuities do carry a guaranteed minimum return, but only if you keep the policy until its maturity date. The guaranteed return is usually 3%, but that may not be 3% of what you paid into the policy in the first place. Some companies guarantee you’ll get at least 3% of 90% of what you spent. Also make sure you check on how that minimum return is computed. If, for example, you get at least 3% compounded annually, that works out to a little more than a 10% gain after seven years.

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