How to determine the best Equity Indexed Annuities
Expected Indexed Annuity Performance:
Index annuities can be the best of both worlds if they have favorable terms. A good index annuity has a high participation rate, high guaranteed minimum rate, low administration fees, high rate cap, and an annual reset provision. When reviewing contracts, weigh all of these factors holistically, as each insurance company strikes a unique balance.
Factors to consider when shopping for an index annuity include:
High Participation Rate Index Annuity
The participation rate is the percentage of growth you receive on positive years. The higher the participation rate, the more you gain from an index’s growth. Small variations in this factor can significantly impact returns, so be sure to find the highest possible. Typical participation rates range from 50%-90% depending on other factors.
Let's see how participation rate affects returns. Let's compare two identical S & P 500 linked annuities, except annuity A has a 50% participation rate while annuity B has 90%. If we invested $100,000 in both and the S & P 500 rose 14%, account A would have $107,000 while account B would have $112,600. A $5,600 or 40% difference.
Because most index annuity earnings stem from moderately positive annual growth, getting a bigger piece of the pie via high participation rate is priority one.
Every index annuity features a minimum rate that you receive during poor-performance years. The minimum rate serves two roles: 1) to protect against potentially catastrophic loss, and 2) to generate moderate growth. Function #1 is far more important and comes for "free" with any index annuity contract. Function #2 is a nicety, but shouldn't be prioritized over a participation rate.
A typically index annuity contract will stipulate a 1-3% minimum rate. Obviously look for the highest rate you can find, but this factor isn't nearly as significant finding a high participation rate. Even a 1% minimum rates serves the purpose of preserving capital.
Let's take a look at how an index annuity protects capital during down years. Suppose we invest in an S & P 500 linked annuity with a 50% participation rate. Suddenly the market turns sour and the S & P 500 drops 40% over the next year. Do you lose 20% of your investment? No! The minimum rate guarantees that even during the worst market crash you’ll still be earning money. If our contract stipulated a 2% guarantee, that's how much we'd earn this year.
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