The annual reset method is unique to fixed annuities and fixed index annuities, capturing and locking any compounded interest earned in the retirement savings plan. As a result, annual reset is the safe interest crediting method to accumulate wealth.
- “Annual” refers to the amount of time between two contract anniversary dates.
- “Reset” refers to the annuity crediting and locking in the interest rate then resetting for the next compounding period.
Think of an annual reset like a flight of stairs. Each time you earn interest you, create a new step in the flight of stairs.
A fixed index annuity owner earns interest based on the performance of an external index like the S&P 500. If you earn zero or less interest in a reset period, nothing happens. Your annuity contract value stays the same. Thus, you do not lose money from the annuity due to negative stock market performance.
The annual reset method offers multiple reset periods that I’ll go over, which can be crucial to earning your interest throughout the annuity.
What Are Annual Resets
The annual reset method for calculating the interest rate in a fixed indexed annuity is sometimes known as the “ratchet” approach. The index term comprises of one or more years, and each contract year has a beginning and endpoint for which an index interest rate is determined.
At the end of the index term, the index interest rates for each contract year in the index term are summed together to create an overall index interest rate for the period. A negative year is typically treated as zero percent under most reset strategies.
Annual Reset Point-To-Point Method
The index closing level at the conclusion of the first year of the index term serves as the index starting level for the second year’s calculation in the point-to-point method. The second year’s ending index closing level becomes the starting index closing level for the third year, and so on.
At the end of each year in the index term period, the reset credits interest to the index annuity’s account. As a result, the accumulated interest compounds on an annual basis.
The annual reset strategy and the multi-year reset approach are essentially identical, with one exception: the multi-year reset method requires calculation periods that are at least two years long, while the annual reset technique simply uses a single year.
Annual Reset Method And Baseball
For fixed indexed annuities, I like to compare an annual reset interest crediting to baseball in which every reset period is a time “at-bat.” Every time you’re up to bat in baseball, you can either get a hit or strike out. The annual reset method works the same way. Each reset period in a deferred annuity, you have the opportunity to earn or not earn interest.
Since there are multiple reset periods, you should be comfortable with how much chance you want to grow your account. The chance isn’t about how much money you will lose (because you can’t), but how much interest one could earn between periods.
The annual reset is like it sounds, which is a reset period of 1 year. Every year you get an opportunity to earn or not earn interest. In a standard 10-year contract, you have ten opportunities to earn or not earn interest.
A reset period of two years in length. Every two years, you have an opportunity to earn or not earn interest. For example, in a standard 10-year contract, you have five chances to earn or not earn interest.
A reset period of three years in length. Every three years, you have an opportunity to earn or not earn interest. For example, in a standard 10-year annuity contract, you have three chances to earn or not earn interest (Year 9).
A reset period of five years in length. Every five years, you have an opportunity to earn or not earn interest. For example, in a standard 10-year contract, you have two chances to earn or not earn interest.
Why Would Anyone Select A Reset Period Of More Than A Year?
Easy answer. More upside potential. The longer the reset periods, the more opportunity to earn higher interest. The tradeoff is the longer the reset period, the fewer opportunities to make up for a lost time, not earning interest.
You open a 10-year indexed annuity contract.
You choose a 2-year reset period.
The first time you’ll ever see any earnings is on the first day of the 3rd year.
The two years go by, and you earn zero interest.
Now you have to wait until another two years to earn interest (or choose a shorter reset period), which is a total of 4 years in length before you see any growth.
That’s a long time to see growth.
Yes, you protect your original principal, but who wants to wait a long time to see any growth?
The other side of that equation is that the earnings probably are greater than an annual reset period if you earn interest.
Now imagine, if you chose a reset period of longer than two years?
That’s where it gets dicey.
I like to say if you’re looking for consistency, stick with an annual reset.
If you’re looking for maximum upside potential over the life of the contract, choose a multi-year reset strategy.
The good news is you can mix and match strategies on most equity-indexed annuities.
You can always change your interest-earning strategy after each reset period. In addition, some annuity owners often elect a backup plan to guarantee their outcome, allowing them to empower their retirement.
If you’re lucky, the life insurance company offers a high minimum guarantee value to back you up in case of not earning anything.