Equity indexed annuities are complicated products that may contain several features that can affect your return. You should fully understand how an equity-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 and return 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 your annuity would be 7.2% (9% x 80% = 7.2%).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 an equity-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 contract’s 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 contract’s term to the highest index value at various points during the contract’s term, often annual anniversaries of when you purchased the annuity.
Before you decide to buy or purchase an equity-indexed annuity, you should understand how each feature works and what impact, it may have on the annuity’s potential return.
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