Patti Fagan Financial & Insurance



2100 Garden Road, Suite 103
Monterey, CA 93940


(831) 238-9097


(408) 317-1865

Indexed Annuities

Like all annuities, an indexed annuity is a contract with an insurance company that provides an income stream — either immediately or at some point in the future — in exchange for premium payments. However, indexed annuities are unique in offering a minimum rate of return (typically 1% to 3%) that helps to preserve principal, along with some potential for gain when the market is riding high.

If the market has a negative year, you would receive at least the minimum return (if the annuity is held until the end of the contractual term). If the market has a positive year, you would receive a higher rate of return, based on the performance of a specified market index such as the S&P 500.


Calculating Return Rates

The participation rate determines how much of the index gain will be credited to the annuity. A participation rate of 80% means the annuity would be credited with only 80% of the gain experienced by the index.

A spread/margin/asset fee may be assessed in addition to, or instead of, a participation rate. If the index gained 10% and the spread/margin/asset fee was 2.5%, then the gain in the annuity would be 7.5%.

The interest-rate cap is the maximum rate of interest the annuity will earn. If the index gained 10% and the cap rate was 6%, the gain in the annuity would be 6%.

Index performance generally does not include dividends. Participation rates, cap rates, and other fees are set by the insurance company. Some companies may change these provisions either annually or at the start of each contract term, which could affect the investment return.

Measuring Index Performance

In addition to participation rates, cap rates, and spread/margin/asset fees, the way in which index performance is measured may vary, depending on the contract, and could make a significant difference in the growth of the annuity.

Annual reset (ratchet). Compares the change in the index from the beginning to the end of each year, “locking in” an investor's gain. Any declines are ignored.

Point-to-point. Compares the change in the index at two discrete points in time, such as the beginning and ending dates of the contract term. Because this method relies on a single point in time (i.e., the last day of the contract), a large decline in the index prior to that point may decrease the interest.

High water mark. Compares the index value at the beginning of the contract to its highest value at various points during the contract (often anniversaries of the purchase date). This method may lead to a higher interest rate than other indexing methods. However, because interest is not credited until the end of the term, there may be no index-linked gain if the annuity is surrendered early.

Most annuities have surrender charges that are assessed if the contract owner surrenders the annuity during the early years of the contract. However, some indexed annuities allow withdrawals of up to 10% per year without surrender charges. Of course, any withdrawals will reduce the principal, and withdrawals before the end of an index period will receive no interest for that period. Early withdrawals prior to age 59½ may be subject to a 10% federal income tax penalty.

Indexed annuities are complex products with rules, restrictions, and expenses, and they are not appropriate for every investor. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company. Depending on the guarantees, it may be possible to lose money with this type of investment. Be sure to review the contract carefully before deciding whether to invest.

The Standard & Poor's 500 index is an unmanaged group of securities that is widely recognized as representative of the U.S. stock market in general. You cannot invest directly in an unmanaged index and do not actually own any shares of an index.