Another advantage of a fixed index annuity is the opportunity to accumulate interest based on changes in an external index.
Some FIAs offer you a choice of indexes rather than just one. In addition to choosing your indexes, you can also determine what portion of your annuity’s value will be based on each index chosen.
Although an external market index or indexes may affect your contract values, the contract does not directly participate in any stock or equity or bond investments. You are not buying shares of any stock or index fund.
FIA’s Indexed Interest Potential
When you purchase a fixed index annuity, you can allocate its value to one or more chosen indexes. A crediting method is then used (which will be defined later) to track the performance of your index(es). At the end of each contract year, the indexed interest is calculated.
If the result is positive, you will automatically receive indexed interest, subject to a participation rate and a cap or spread (which will also be defined later). That interest is locked in each year and cannot be lost due to index declines at some point in the future.
If the result is negative, nothing happens – and that can be good news! Although you won’t receive any indexed interest for the year, your annuity’s value doesn’t decline.
Factors that influence how a FIA’s indexed interest is calculated
When you purchase your fixed indexed annuity, you can often choose the index(es) to which you allocate your annuity’s value. You can also choose the crediting method used to track changes in your chosen index(es). Before discussing those crediting method choices, it’s good to look at some other factors that will affect how your indexed interest is calculated.
Some fixed index annuities set a maximum rate of interest (or cap) that the contract can earn in a specified period (usually a month or year). If the chosen index increase exceeds the cap, the cap is used to calculate your interest.
In some annuities, a participation rate determines how much of the index increase will be used to calculate your indexed interest. (Participation rates are generally applied after caps, and before a spread.)
The indexed interest for some annuities is determined by subtracting a percentage from any gain the index achieves in a specified period. For example, if the annuity has a 4% spread and the index increases 10%, the contract is credited 6% indexed interest.
FIA Crediting Method Choices
No single crediting method consistently delivers the most interest under all market conditions.
A quick definition of some popular crediting method choices is provided below. For a better understanding of how each crediting method works, talk to us and we are happy to provide you with additional information. Keep in mind that caps, participation rates, and spreads will also enter into the calculation of indexed interest, and may reduce the amount of interest credited.
Annual point-to-point. This method tracks changes in the market index from one contract anniversary to the next and credits interest based on that annual change.
Monthly sum. With this method, individual monthly increases and decreases in the index values are tracked and added up. Their sum helps determine the indexed interest credited to the annuity.
Monthly average. For this method, the individual monthly index values are totaled, and then divided by 12 to find the average. The starting index value is subtracted from the average to determine the amount of positive or negative index change. This amount is divided by the starting value to determine the percentage of interest credited to the annuity.
The Benefits of Automatic Annual Reset
Annual reset is a common FIA feature. At the end of each contract year, your annuity’s index values are automatically reset. This means this year’s ending value becomes next year’s starting value. Annual reset also locks in any interest your contract earned during the year.