How does the interest calculation in Fixed Index Annuities work? Fixed Index Annuities pay interest based on a formula calculation that is tied to a stock index such as the S&P 500. In addition to a market index, the formula calculation also uses a number of components to determine how much interest you will be paid, and when that interest will be paid.
There are two main components that influence the interest calculation formula in a Fixed Index Annuity. They are the Indexing Method and the Participation Rate.
The indexing method is used to measure the amount the index has changed. The most common indexing methods include an annual reset, a high-water mark, and a point-to-point method.
Annual Reset: The Fixed Index Annuity interest rate is calculated by comparing the index value at the end of the contract year, with the index value at the start of the contract year.
Point-to-Point: The Fixed Index Annuity interest rate is based on the difference between the index value at the end of a defined period of time, and the index value at the start of that period of time. The Point-to-Point can be monthly or annual.
High-Water Mark: The Fixed Index Annuity interest rate is determined by measuring the index value at various points during a defined period of time. Often, the annual anniversary of the date you purchased the Annuity is used as a measuring point. The interest payment is based on the difference between the highest value of the index during the period, and the value of the index at the start of the period.
The participation rate is used to determine how much of the index increase will be used to calculate your interest. Your participation rate will be set by the insurance company upon funding the Annuity, and will usually be guaranteed for a specific term. Once that term is over, the insurance company will set a new participation rate. Often, your Fixed Index Annuity will provide a guarantee that your participation rate will never be set below or above a certain rate. An example of a participation rate is as follows. If your participation rate is set at 75% of the S&P 500, and the S&P 500 gains 10%, your interest rate will be set at (10% X 75% = 7.5%). Your Annuity will earn 7.5% interest in that term.
In addition to the Indexing Method and Participation Rate, the other components that will affect your Fixed Index Annuity Interest Rate are:
A Fixed Index Annuity may define an upper limit cap, or ceiling, on the index-tied interest rate calculation. The Cap Rate defines the maximum rate of interest the Fixed Index Annuity will earn. Some, but not all, Fixed index Annuities have a Cap Rate.
Uncapped crediting is relatively new and has been gaining in popularity since 2014. Its popularity is due to the potential of higher index returns as the ceiling on earnings is removed. This strategy allows for a full earnings of the index based on after the initial restrictions of the control of a Participate Rate or the Margin assessment has been resolved.
The minimum interest rate defines the minimum interest you will earn for the term. It is common for a Fixed Index Annuity to define the interest floor as 0%. With a 0% floor in a bad stock market period you may not earn interest, but you will never suffer a decrease in Annuity value.
A Fixed Index Annuity may use an average of an index value rather than the actual value of the index on a specified date. The index average may be taken at the beginning, the end, or throughout the entire term of the Annuity.
A Fixed Index Annuity may calculate the index-tied interest rate by subtracting a pre-defined percentage from any earnings as a result of the index growth. This percentage is typically referred to as the Margin, Spread, or Administrative Fee.
When the index records a gain, the Margin is subtracted first. All gains after the Margin is assessed are added to the Annuity as earned interest. The advantage to this strategy is that all caps and ceilings are removed and you will receive the full measure of all gains after the Margin has been assessed. In some Fixed Index Annuities, Margin may be used as a crediting strategy instead of a Participation Rate. They are charged ONLY when there is a gain for the year. If there is no gain, the charge is not accessed.
To find the best Fixed Index Annuity product for your retirement, it is recommended that you compare Fixed Index Annuities from the nation’s top rated insurance companies. Working with an independent Annuity Advisor will give you access to multiple products from multiple companies. Fixed Index Annuities can only be sold by properly licensed Annuity Advisors. AnnuitySeeker can help connect you to a properly state-licensed Annuity Advisor in your area.