Finding The Best Fixed Indexed Annuities
Which Is The Best Fixed Indexed Annuity?
There are many factors that should be considered to find the best fixed indexed annuity, such as a high cap and participation rate. Fixed Indexed 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.
Each insurance company and annuity carrier offer their own unique products, and will often have several different fixed indexed annuities to choose from with multiple options.
Main Factors To Consider
What to look for when choosing a fixed indexed annuity:
- High Participation Rate – The percentage of growth you receive on positive years.
- High Cap Rate – The maximum percentage the account value can increase in a year or specified term.
- Competitive Crediting Method – The crediting method determines how the index gains are calculated and credited to the account.
- Solid Minimum Rate – The minimum interest rate that you can receive during the length of the contract.
Considering these factors work towards maximizing returns while reducing risk.
Choose Fixed Indexed Annuities With A High Participation Rate
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. If we 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 number one.
Look For A High Cap Rate
Most indexed annuities include a yield or rate cap. It sets a limit on the amount that can be credited to the account per year. For example, a 7% rate cap limits the credited yield to 7% no matter how much the stock index gained. Rate caps typically range from a high of 15% to as low as 4% and are subject to change.
For example, if the index had a return of 10% gain in a given year, the annuity would be credited those gains up to the 7% cap, but nothing beyond that.
There are also Cap Rates that protect the downsides of the market as well. These rates typically range between 0% (meaning the account value never goes down in negative years) to 10%. The vast majority of fixed indexed annuities cap downside year losses at 0%.
Select A Competitive Crediting Method
The crediting method of an indexed annuity determines how interest is calculated for a fixed index annuity. The crediting method chosen measures the amount of interest that the annuity holder can receive over a specific time period.
Most contracts include a combination of caps (maximum interest allowed), participation rates (fraction of interest credited to the contract) and spreads. These limit the upside potential of increases in index value.
Some of the crediting methods used by insurance companies include:
- Annual point-to-point averaging
- Biannual point-to-point averaging
- Monthly point-to-point averaging
- Daily averaging / monthly averaging
- Hindsight index strategy monthly averaging
Select A Fixed Indexed Annuity With A High Minimum Rate
Every indexed annuity features a minimum rate that you will receive during the course of the contract. 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 typical index annuity contract will stipulate a 1-3% minimum rate. Obviously you’ll want to look for the highest rate you can find, but this factor isn’t nearly as significant as finding a high participation rate.
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.