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Fixed-Indexed Annuities
Overview
A fixed-indexed annuity is a type of annuity that grows at the greater of a) an annual, guaranteed minimum rate of return; or b) the return from a specified stock market index (such as the S&P 500®), reduced by certain expenses and formulas. At the time the contract is opened, a term is chosen, which is the number of years that the principal is guaranteed.
Fixed vs. Fixed-Index Annuities
Technically speaking, fixed-indexed annuities are a type of fixed annuity. But a fixed-indexed annuity is different than a standard fixed annuity in the way that earnings are credited to the annuity. For a standard fixed annuity, the issuing insurance company guarantees a minimum interest rate. The focus is on safety of principal and stable, predictable investment returns. With fixed-indexed annuities, the contract return is the greater of a) an annual minimum rate, or b) the return of a stock market index (such as the S&P 500®), reduced by certain expenses and formulas. If the chosen index rises sufficiently during a specified period, a greater return is credited to the owner’s account for that period. If the stock market index does not rise sufficiently, or even declines, the lower minimum rate is credited. The owner is guaranteed to receive back at least all principal (provided of course that the owner has held the contract for the minimum period of time specified in the contract).
Participation / Index Rates
The participation rate, also known as the index rate, is the percentage increase in the index by which a contract will grow. For example, if the participation rate is 75% for a fixed-indexed annuity that is based on the S&P 500®, and the S&P 500® increases 10% for the year, the contract would be credited with 7.5%. The participation rate is usually less than 100%. The participation rate will vary based on length of the term and on your contract. NOTE: The participation rate is guaranteed for the length of the term, but may be reset at renewal.
Floor & Cap Rate
The floor refers to the minimum guaranteed amount credited to the account. The cap rate is the annual maximum percentage increase allowed. For example, if the chosen market index increases 35%, and the contract has a 14% cap, the increase will be limited to 14%. Some contracts do not have a cap rate. The cap varies depending on the length of your term. NOTE: The cap may reset annually and is subject to change at each renewal.
Index Credit Period
There are three basis ways in which amounts are credited to an owner’s contract at specific points in time. The three most common ways to determine credited amounts are as follows:
- Annual reset: this measures the change in the market index over a one-year period.
- Point-to-point / term: similar to the annual reset, but the period is usually five years.
- Annual high water mark with look back: the highest anniversary value is used to determine the gain
For an example of each of these index credit periods, click here.
Fees
While there is typically no commission charged when purchasing a fixed-indexed annuity, there are administrative fees to cover the insurer’s basic expenses. These fees can range from 1.0% to 2.25%. Surrender charges may be imposed if withdrawals in excess of a certain amount are made or if the contract is surrendered completely. Surrender charges can range from 0% to 10% and typically decline over time. For more information on surrender charges, click here and look under “Liquidity Options.”
Regulation
Unlike variable annuities, fixed-indexed annuities are usually not registered or regulated with / by the SEC. An insurance company may register a fixed-indexed annuity product with the SEC, and must do so under certain circumstances. If a fixed-indexed annuity is registered, a prospectus (a document which provides detailed information on how an annuity contract works, the risks involved, and all expenses or charges) must be provided to the buyer. Only individuals with both securities and insurance licenses may sell registered fixed-indexed annuities.
Other Features
Some fixed-indexed annuity contracts offer, as an optional feature and for an additional fee, a guaranteed death benefit. If an annuitant dies before annuity payments begin, the contract will pay the names beneficiary the greater of the investment in the contract (less any withdrawals) or the contract value on the day of death. For more information on annuity death benefits, click here.
