What is an Index Annuity Strategy?

Shawn Plummer

CEO, The Annuity Expert

A fixed index or equity index annuity will grow based on an external index performance’s positive performance. Thus, an index annuity strategy determines how an owner earns interest. An index annuity rate is the percentage of interest that can be credited to an annuity owner in a fixed indexed annuity product.

Premiums allocated to one of the Index Strategies will receive interest calculated about the upward movement, if any, of an external market index, modified by limitations such as a Cap Rate, Annual Spread, or a Participation Rate.

The interest credited by the strategies may be different than the performance of the indices themselves.

Interest credits are guaranteed never to be less than zero.

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Fixed Index Annuity Rate Types

Cap Rate

A cap rate is the maximum rate (ceiling or cap) of interest the annuity will earn during the index term.

For example, if the applicable index increases by 5% and there is a 3% Cap, the interest credited would be 3%.

Participation Rate

Participation rates are the percentage of the upside an indexed annuity owner can participate in when selecting a crediting method. 

For example, if the applicable index increases by 5% and there is a 60% Participation rate, the interest credited would be 3%.

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Fee Rate

Annuity fees are the charges you incur for a benefit from the insurance or financial company.  

Fees are deducted regardless of a positive or negative movement from the index.

Fees can reduce your annuity’s value.

Spread Rate

Annuity spreads are the percentage that is subtracted from the index change before interest is calculated.

For example, if the applicable index increases by 5% and there is a 2% Annual Spread, the interest credited would be 3%.

Spreads typically only apply to positive movements from the index and do not reduce your annuity’s value during negative movements.

Fixed Interest Rate

A declared fixed rate is credited annually. 

The interest rate can change every year in an equity-indexed annuity contract.

Crediting Methods

Annuity index crediting methods is how growth to your fixed index annuity is determined.

The annual reset method in index annuities offers the ability to “lock-in” your gains without going backward in value, even in down and volatile markets.

Point to Point Indexing Method

The Index Credited Amount under a Point-to-Point Indexing Method is calculated based upon the percentage change of the Index Value from the beginning of an Index Period to the end of the Index Period, the Index Rate.

If the Index Rate is positive, the Net Index Rate will equal the Index Rate, either multiplied by the Participation Rate or limited by the Cap, as may apply.

If the Index Rate is negative or zero, there is no Index Credited Amount.

Monthly Point to Point Indexing Method

The Index Credited Amount under the Monthly Point-to-Point Method is calculated based on the sum of the 12 capped monthly index changes during the Index Period.

The monthly index changes are equal to the point-to-point percentage increases or decreases over each month of the Index Period from the starting Index Date to the ending Index Date.

Each index change cannot exceed the monthly Cap.

The Net Index Rate under the contract is equal to the sum of the 12 capped rates.

The Indexed Credited amount is subject to a minimum of 0%.

The monthly index changes may be positive or negative, but the credited interest will never be less than zero.

If the Index Rate is negative or zero, there is no Index Credited Amount.

Point to Point Inversion Indexing Method

The Index Credited Amount under a Point-to-Point Inversion Indexing Method is calculated based upon the Index Rate.

Unlike the traditional Point-to-Point Indexing Method, under a Point-to-Point Inversion, if the Index Rate is negative, the Net Index Rate will equal the absolute value of the negative Index Rate, limited by the Cap.

If the Index Rate is positive or zero, there is no Index Credited Amount.

High-Water Mark

Interest is calculated using the highest value of the index on a contract anniversary during the term; this design may credit higher interest than some other designs if the index reaches a high point early or in the middle of the term and then drops off.

Some trade-offs with this crediting strategy may be the interest is not credited until the end of the term.

In some annuities, you may not get index-linked interest for that term if you surrender your annuity before the end of the term.

You may receive index-linked interest in other annuities based on the highest anniversary value to date and the annuity’s vesting schedule.

Also, contracts with this design may have a lower participation rate than annuities using other designs or use a cap to limit the total amount of interest you might earn.

Low-Water Mark

Interest is calculated using the lowest value of the index before the end of the term; this design may credit higher interest than some other designs if the index reaches a low point early or in the middle of the term and then rises at the end term.

Some tradeoffs with this strategy might be the interest is not credited until the end of the term.

With some annuities, if you surrender your annuity before the end of the term, you may not get index-linked interest for that term.

You may receive index-linked interest in other annuities based on comparing the lowest anniversary value to date with the index value at surrender and the annuity’s vesting schedule.

Also, contracts with this design may have a lower participation rate

Renewal Rates

Renewal Rates are what the fixed interest rate will become after the guaranteed term in a fixed contract.

For indexed contracts, renewal rates will apply to the caps, participation rates, spreads, fees, and the fixed interest amount that renews at every anniversary or reset period. 

Every type of deferred insurance contract (fixed and indexed) will have a minimum guaranteed rate, which is the “floor” the crediting rate will never fall below. This floor is established at the time of purchase and applies the life of the contract.

Some deferred contracts have a bailout rate as a special feature. Essentially this allows a contract to become 100% liquid if the renewal rate falls below a set rate. If your rate ever renews at or below the set bailout rate, you can withdraw all of your money without a penalty.

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Frequently Asked Question

Can I change which interest option applies to my money?

In general, you may transfer all or a portion of the amounts in the Declared Interest Account and/or each Participation Account to a different interest option at the end of each Term Period or Index Period, as may apply.

Are dividends included in the index?

Depending on the index used, stock dividends may or may not be included in the index’s value. For example, the S&P 500 is a stock price index and only considers the prices of stocks. Therefore, it does not recognize any dividends paid on those stocks.

Shawn Plummer

CEO, The Annuity Expert

I’ve sold annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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