Contract Features of Equity-Indexed Annuities
Equity-indexed annuities are complicated products that may contain several features that can affect your return. You should fully understand how an equity-indexed annuity computes its index-linked interest rate before you buy. An insurance company may credit you with a lower return than the actual index�s gain. Some common features used to compute an equity-indexed annuity�s interest rate include:
Participation Rates. The participation rate determines how much of the index�s increase will be used to compute the index-linked interest rate. For example, if the participation rate is 80% and the index increases 9%, the return credited to your annuity would be 7.2% (9% x 80% = 7.2%).
Interest Rate Caps. Some equity-indexed annuities set a maximum rate of interest that the equity-indexed annuity can earn. If a contract has an upper limit, or cap, of 7% and the index linked to the annuity gained 7.2%, only 7% would be credited to the annuity.
Margin/Spread/Administrative Fee. The index-linked interest for some annuities is determined by subtracting a percentage from any gain in the index. This fee is sometimes called the �margin,� �spread,� or �administrative fee.� In the case of an annuity with a �spread� of 3%, if the index gained 9%, the return credited to the annuity would be 6% (9% - 3% = 6%).
Another feature that can have a dramatic impact on an equity-indexed annuity�s return is its indexing method (or how the amount of change in the relevant index is determined). Some common indexing methods include:
Annual Reset (or Ratchet). This method credits index-linked interest based on any increase in index value from the beginning to the end of the year.
Point-to-Point. This method credits index-linked interest based on any increase in index value from the beginning to the end of the contract�s term.
High Water Mark. This method credits index-linked interest based on any increase in index value from the index level at the beginning of the contract�s term to the highest index value at various points during the contract�s term, often annual anniversaries of when you purchased the annuity.
These and other features may be included in an equity-indexed annuity you are considering. Before you decide to buy an equity-indexed annuity, you should understand how each feature works and what impact, together with other features, it may have on the annuity�s potential return.�