Fixed annuities ensure your income based on current interest rates. Going through a long retirement horizon, you may want to take into account relying a little on the markets to boost you annuity income. Indexed annuities offers that possibility, but you must understand how they work.
Indexed annuities combine top features of traditional insurance products (stated in advance minimum return) and variable securities (where the return is related to equity markets).
Here's how equity indexed annuities work:
Throughout the accumulation period - if you make either a lump sum payment or possibly a series of payments - the insurance company credits your account with a return based on changes in a common equity index. The S&P 500 is a common index (the S&P 500 is an unmanaged index regarding 500 of the largest cap US stocks and cannot always be invested in directly). Indexed annuities can have a great return because of their market indexing, but there are trade offs.
The insurance company usually guarantees a minimum return regarding on the order of 2.5% annually. So even if the S&P 500 stays flat for your entire term, you'd still get 2.5% on your money. Surrender charges can last for a few years (like early withdrawal penalties) and if you do take an early withdrawal,most contracts will not provide any index-linked interest. If there is no increase in the root index during the designated term, account holders receive only the minimum assured rate minus expenses and distributions.
After the accumulation period or growth period, the equity indexed annuity company will make intermittent payments to you unless you require take your contract price as a lump sum. Index annuities are a great way to invest long term for an income over your retirement years.
Understanding how the particular interest rate used in your contract is related to the equity index determines what gain you really get over a fixed annuity. To understand procedures in the linking method, let's take a look at the components of indexed annuities:
Features of Indexed Annuities
Participation Rates: The participation rate determines how much of the index's increase will be used to compute the index-linked interest rate. For instance, if the participation rate is 75% and the index increases 10%, the return deposited into your annuity would be 7.5% (10% x 75% Equals 7.5%).
Interest Rate Caps: Some indexed annuities contain a maximum rate of interest that this equity-indexed annuity can earn. If a agreement has an upper limit, or limit, of 7% and the index linked to the annuity acquired 7.5%, only 7% would be added to the annuity balance.
The Margin, Distributed or Administrative Fee: The particular index-linked interest for some annuities is determined by subtracting a 'fee' percent from any gain in the index. This specific fee is sometimes called the 'margin,' 'spread,' or perhaps 'administrative fee.' An annuity with a 'spread' associated with 3%, will credit a return of just 7% if the index gained 10% (i.e. 7% = 10% - 3%).
The method associated with indexing the index change will influence your return too. A few indexing methods are:
Annual Reset (or Ratchet). This method credits index-linked interest determined by any increase in index value on a year by year basis so that a decline in the index in a later year will not erase any gain from an earlier year. This is a great feature of some indexed annuities for conservative investors.
Point-to-Point. This technique credits index-linked interest in a more risky (but having potential for more gain) from the first day to the last day of the contract.
Fine a qualified agent to shop for an explain indexed annuities to you.