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Two
Main Annuity
Types: Immediate and
Deferred
The difference between deferred and immediate annuities is just about what you'd think.
With an immediate annuity, your income payments start right away. You choose whether you want income guaranteed for a specific number of years or for your lifetime. The insurance company calculates the amount of each income payment based on your purchase amount and your life expectancy.The payout phase begins
when you decide
to take income from your annuity. For most people, this is during
retirement. As your needs dictate, you can take partial withdrawals,
completely cash-out (surrender) your annuity, or convert your deferred
annuity into a stream of income payments (annuitization). This last
option is essentially the same as buying an immediate annuity.
Stock Market Growth With No Market Risk
How would you like to own an annuity that locks in stock market gains when the market is rising, but also protects your investment against any losses when the market is falling? That's right, your policy value is never reduced because of negative stock market performance.
Believe it or not, there is such an investment product and it's called an Equity-Indexed Annuity.
With an Equity-Indexed Annuity, your return is tied to the increase in one of several stock market indexes, such as the S&P 500. However, if the stock market goes down, you do not lose any of your money. In fact, most Equity-Indexed Annuities will even GUARANTEE you a minimum annual return (typically 3%), even if the index you invested in goes down the entire time you are invested.
For a compete discussion of contract features, indexing methods and guarantees, see "Equity-Indexed Annuities Explained".
An Equity-Indexed Annuity is a great place to protect the money you've saved in your CDs, money market accounts, IRA accounts, etc. Or perhaps as an alternative for the money you currently have invested in stocks and mutual funds. Equity-Indexed Annuities can greatly improve your earnings potential, while at the same time keep your principal safe from market fluctuation
Equity-Indexed Annuities Explained
An equity-indexed annuity is an annuity that earns interest that is linked to a stock or other equity index. One of the most commonly used indices is the Standard & Poor's 500 Composite Stock Price Index (the S&P 500).
HOW ARE THEY DIFFERENT FROM OTHER FIXED ANNUITIES?
An equity-indexed annuity is different from other fixed annuities because of the way it credits interest to your annuity's value. Most fixed annuities only credit interest calculated at a rate set in the contract. Equity-indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how the additional interest, if any, is calculated and credited. How much additional interest you get and when you get it depends on the features of your particular annuity.
Your equity-indexed
annuity, like other fixed
annuities, also promises to pay a minimum interest rate. The rate that
will be applied will not be less than this minimum guaranteed rate even
if the index-linked interest rate is lower. The value of your annuity
also will not drop below a guaranteed minimum. For example, many single
premium annuity contracts guarantee the minimum value will never be
less than 90 percent (100 percent in some contracts) of the premium
paid, plus at least 3% in annual interest (less any partial
withdrawals). The insurance company will adjust the value of the
annuity at the end of each term to reflect any index increases.
Two features that have the greatest effect on the amount of additional interest that may be credited to an equity-indexed annuity are the indexing method and the participation rate. It is important to understand the features and how they work together. The following describes some other equity-indexed annuity features that affect the index-linked formula.
Indexing
Method
The indexing method means the approach used to measure the amount
of change, if any, in the index. Some of the most common indexing
methods, which are explained more fully later on, include annual reset
(ratcheting), high-water mark and point-to-point.
Participation
Rate
The participation rate decides how much of the increase in the
index will be used to calculate index-linked interest. For example, if
the calculated change in the index is 9% and the participation rate is
70%, the index-linked interest rate for your annuity will be 6.3% (9% x
70% = 6.3%). A company may set a different participation rate for newly
issued annuities as often as each day. Therefore, the initial
participation rate in your annuity will depend on when it is issued by
the company. The company usually guarantees the participation rate for
a specific period (from one year to the entire term). When that period
is over, the company sets a new participation rate for the next period.
Some annuities guarantee that the participation rate will never be set
lower than a specified minimum or higher than a specified maximum.
Cap Rate or
Cap
Some annuities may put an upper limit, or cap, on the index-linked
interest rate. This is the maximum rate of interest the annuity will
earn. In the example given above, if the contract has a 6% cap rate,
6%, and not 6.3%, would be credited. Not all annuities have a cap rate.
Floor on
Equity Index-Linked Interest
The floor is the minimum index-linked interest rate you will earn.
The most common floor is 0%. A 0% floor assures that even if the index
decreases in value, the index-linked interest that you earn will be
zero and not negative.
Averaging
In some annuities, the average of an index's value is used rather
than the actual value of the index on a specified date. The index
averaging may occur at the beginning, the end, or throughout the entire
term of the annuity.
Margin/Spread/Administrative
Fee
In some annuities, the index-linked interest rate is computed by
subtracting a specific percentage from any calculated change in the
index. This percentage, sometimes referred to as the "margin,"
"spread," or "administrative fee," might be instead of, or in addition
to, a participation rate. For example, if the calculated change in the
index is 10%, your annuity might specify that 2.25% will be subtracted
from the rate to determine the interest rate credited. In this example,
the rate would be 7.75% (10% - 2.25% = 7.75%). In this example, the
company subtracts the percentage only if the change in the index
produces a positive interest rate.
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HOW DO THE COMMON INDEXING METHODS DIFFER?
Annual Reset
Index-linked interest, if any, is determined each year by comparing
the index value at the end of the contract year with the index value at
the start of the contract year. Interest is added to your annuity each
year during the term.
High-Water
Mark
The index-linked interest, if any, is decided by looking at the
index value at various points during the term, usually the annual
anniversaries of the date you bought the annuity. The interest is based
on the difference between the highest index value and the index value
at the start of the term. Interest is added to your annuity at the end
of the term.
Point-to-Point
The index-linked interest, if any, is based on the difference
between the index value at the end of the term and the index value at
the start of the term. Interest is added to your annuity at the end of
the term.
WHAT ARE SOME OF THE ADVANTAGES AND DISADVANTAGES OF DIFFERENT INDEXING METHODS?
Generally, annuities offer preset combinations of indexing features. You may have to make trade-offs to get features you want in an annuity. This means the annuity you choose may also have some features you don't want.
Advantages | Disadvantages |
---|---|
Annual Reset | |
Since the interest earned is "locked in" annually and the index value is "reset" at the end of each year, future decreases in the index will not affect the interest you have already earned. Therefore, your annuity using the annual reset method may credit more interest than annuities using other methods when the index fluctuates up and down often during the term. This design is more likely than others to give you access to index-linked interest before the term ends. | Your annuity's participation rate may change each year and generally will be lower than that of other indexing methods. Also, an annual reset design may use a cap or averaging to limit the total amount of interest you might earn each year. |
High-Water Mark | |
Since 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, then drops off at the end of the term. | Interest is not credited until the end of the term. In some annuities, if you surrender your annuity before the end of the term, you may not get index-linked interest for that term. In other annuities, you may receive index-linked interest, 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 may use a cap to limit the total amount of interest you might earn. |
Point-to-Point | |
Since interest cannot be calculated before the end of the term, use of this design may permit a higher participation rate than annuities using other designs. | Since interest is not credited until the end of the term, typically six or seven years, you may not be able to get the index-linked interest until the end of the term. |
Cap on
Interest Earned
While a cap limits the amount of interest you might earn each year,
annuities with this feature may have other product features you want,
such as annual interest crediting or the ability to take partial
withdrawals. Also, annuities that have a cap may have a higher
participation rate.
Averaging
Averaging at the beginning of a term protects you from buying your
annuity at a high point, which would reduce the amount of interest you
might earn. Averaging at the end of the term protects you against
severe declines in the index and losing index-linked interest as a
result. On the other hand, averaging may reduce the amount of
index-linked interest you earn when the index rises either near the
start or at the end of the term.
Participation
Rate
The participation rate may vary greatly from one annuity to another
and from time to time within a particular annuity. Therefore, it is
important for you to know how your annuity's participation rate works
with the indexing method. A high participation rate may be offset by
other features, such as averaging, or a point-to-point indexing method.
On the other hand, an insurance company may offset a lower
participation rate by also offering a feature such as an annual reset
indexing method.
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