Indexed annuity

Fixed annuities are insurance products which protect against the risk of outliving your income. They are insured by licensed and regulated insurance companies, similar to how your home, auto or health is insured. And just like your home, auto and health insurance, they are backed by the insurance company up to stated policy limits. State insurance guarantees vary from state to state, and may not cover 100% of the Annuity Value. For example, in California the fund will cover "80% not to exceed $250,000."

There are two types of fixed annuities: traditional fixed and indexed annuities. (A third type of annuity, called a variable annuity, is not discussed here since it is not a type of fixed product.)

Fixed annuities are regulated by state insurance departments and sold through insurance agents, banks, or registered representatives. Section 989J of the Act (also known as the Harkin Amendment) is targeted at removing equity indexed annuities from SEC jurisdiction. This provision will require the SEC to treat certain state-regulated annuities as exempt securities under the Securities Act of 1933, and therefore not subject to SEC registration requirements. Fixed annuities pursuant to state insurance law must provide a minimum rate of interest as provided in the annuity policy. How the actual rate of interest is credited on the policy differentiates traditional fixed annuities from indexed annuities. Traditional fixed annuities pay interest on the premium contributed at a rate declared by the insurer in advance. Some traditional fixed annuities offer multiple years guaranteed at the same rate, while others will leave the insurance company with the ability to adjust the rate annually. This rate can never be less than the minimum guaranteed rate stated in the policy. Fixed annuities are a very conservative safe money place for retirement dollars. Fixed annuity interest rates are generated from a portfolio of US treasuries or other low risk, fixed income instruments.

Indexed annuities are a type of fixed annuity which are regulated and distributed in the same manner as fixed annuities (through licensed insurance agents). Indexed annuities are a conservative safe money place for retirement dollars. Indexed annuities usually provide a purchaser with various options for interest crediting. A buyer does have an option to elect a declared interest rate, which generally allows an allocation of anywhere from 0-100% of the account value, and functions the same as a traditional fixed annuity. However, the annuity is designed for higher potential interest rates, and provides other allocation options which consider the performance of an outside stock index (such as the Standard and Poor's 500, a.k.a. S&P 500) to determine the rate of interest. These options pay interest at a rate determined by a formula which considers any increase in the outside index, often subject to a “participation rate”, and/or “cap, and/or "spread”. All indexed annuities have a floor of zero, meaning the absolute worst-case scenario due to a downturn in the market index is a consumer might receive no interest in a particular year, however, he or she cannot lose any previously credited interest or premiums. A “participation rate” is a set percentage multiplied by any percentage increase in the outside index. For instance, if a particular index crediting method offers a 50% participation rate, and the calculated return was 10% for the year, the policy would earn a rate of 5% (10% calculated return x 50% participation = 5% return). A "cap" is a set maximum percentage based on the performance of the outside index. For instance, if a particular index crediting method offers a 6% cap, and the calculated return was 10% for the year, the policy would earn a rate of 6%. A "spread" is a percentage of reduction between the calculated return and the interest rate the consumer will be credit with. For instance, if a particular index crediting method offers a 4% spread, and the calculated return was 10% for the year, the policy would earn a rate of 6% (10% calculated return - 4% spread = 6% return). All participation rates, caps and spreads are set by the insurance company at the beginning of a policy. Unless guaranteed in the policy, the insurance company has the ability to adjust them on an annual basis. Participation rates, caps and spreads are known as "moving parts". Most annuities being issued today have only one moving part in determining an index calculation (i.e. only a cap or only a participation rate), however, it is possible to have multiple moving parts in determining an index calculation (i.e. a cap combined with a participation rate). An annuity with multiple moving parts is not necessarily better or worse than an annuity with only one moving part, and there is no way of determining in advance of a policy year whether a participation rate, cap and/or spread will yield the best performance.

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Wikipedia