Equity Indexed Annuity

Equity Indexed Annuity

An equity indexed annuity is a type of annuity that has a variable interest rate. The interest rate earned on an equity indexed annuity is dependent upon which stock or equity index to which the annuity is linked. The most common benchmark used by equity indexed annuity contracts is the Standard & poor’s 500, or S&P 500.

Equity Indexed Annuity Plans

Equity indexed annuity plans differ from regular fixed rate annuities in the method used to value the each. Fixed rate annuity contracts determine the value of the annuity by calculating interest at a set rate determined by the specifications of the investor’s contract. Equity indexed annuity plans gain value using a specific formula that adjusts the annuity’s value based on the fluctuations of the stock market index to which the annuity is benchmarked to. However, in most contracts, even if the index loses money, the annuity contract will guarantee a minimum rate of increase.

There are two main factors that directly affect the value of the equity indexed annuity: the indexing method of an annuity and the participation rate. The indexing method is the way in which the insurance company measures the index to which the annuity is pegged. It can either be measured by an annual reset, a high water mark, or point to point. The participation rate is calculated by the insurance company and is multiplied by the percentage change in the index to determine the annuity interest rate.

Using the annual reset calculation to determine equity indexed annuity rates, the insurance company will compare the value of the index at the start of the contract with its value at the end of each contract year. High water mark calculations use the high and low point of each contract year to determine the value. Point to point calculations of equity indexed annuity plans look specifically at the index value at the end of the contract year compared to the start to determine the annuity’s value.

Equity Indexed Annuity Plan Pros and Cons

Equity indexed annuity plan pros and cons must be balanced to determine their attractiveness. The main advantage of an equity indexed annuity is that the investor is still guaranteed a base rate of growth while still having the opportunity to make better gains depending on the performance of the index to which the annuity is linked. The value of an equity indexed annuity is typically guaranteed to retain a specific value, such as never less than 90% of its original value. Some insurance companies will even offer to guarantee 100% of the annuity value if all premiums are paid on time.

One of the biggest problems with an equity indexed annuity is the risk that the index to which the annuity is pegged will go down significantly. While the investor may be protected from losing money, the rate cap may be 0%, meaning the annuity would not gain value, either.

Equity Indexed Annuity Plans Explained

Most insurance companies will also have a maximum rate that annuities can earn as well, so that no matter how well the pegged index performs, only a certain amount can be used in determining the annuity interest rate. To avoid higher risk, make sure your insurance company’s participation rate is not set to low, since the participation rate can directly affect the interest earned on the equity indexed annuity.

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