A fixed-indexed annuity (also known as a hybrid or equity 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 until the principal is guaranteed and the surrender period is finished. In a robust stock market, you will not achieve the actual performance of the index due to the formulas, spreads, participation rates, and caps applied to fixed-indexed annuities, as well as because of the absence of dividends (see below). However, in a down market you won’t ever lose principal (provided the underlying insurance company stays solvent, and to date no insurance company has ever failed to pay out on a fixed annuity). Many investors find that fixed-indexed annuity returns more closely approximate CDs, traditional fixed annuities, or high grade bonds, but with the potential for a small hedge against inflation in an up market.
Some contracts do not have a cap rate (these tend to have a lower participation rate, such as 30% to 50% compared with 75% to 100% for a plan with a cap rate). The cap varies depending on the length of your term — fixed-indexed annuities with longer commitment periods (surrender periods) tend to have a higher cap rate, whereas annuities with shorter surrenders periods tend to have a lower cap rate. NOTE: The cap may reset annually and is subject to change at each renewal.
- 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 to seven years.
- Annual high water mark with look back: the highest anniversary value is used to determine the gain.
- Monthly Averaging: you have 12 “month-a-versary” points throughout the year, and at the end of each year the insurance company adds them up and divides by 12.
For an example of each of these index credit periods, click here.
Surrender charges can be as high as 10% on non-bonus contracts and 22% on bonus contracts. Surrender charges typically decline over time, usually by 1% per year. For more information on surrender charges, click here and look under “Liquidity Options.”
With the GLWB, the principal will usually compound at 6% to 8% for a minimum of 10 years, at which point the owner can begin to withdrawal (usually 5% at age 65, for life).