Indexed Annuity – A Hybrid of Option of Fixed and Variable
August 5th, 2010 | Author: weissheiss
Understanding The Basics of Indexed Annuities
One of the main points of interest individual investors have when making an annuity contribution is the underlying growth potential offered for their capital. Fixed annuities offer a specified rate of interest on an annual basis as stated by the insurance company. Variable annuities offer the annuity owner the ability to self-direct their funds into either the general account, managed by the insurance company, or into a variety of equity investment options such as bonds, cash, individual securities or mutual funds. A variation offered by many insurance companies today is the indexed annuity.
Sales within this category of annuities have grown substantially in the past 5 years. An indexed annuity offers the account owner upside potential and often downside protection. The growth offered within these accounts is tied to major indexes such as the S&P 500. There are several indexes which insurance companies can choose to base their interest rate growth potential on.
Indexed annuities are often offered to account holders with participation rates. When the investor participates fully, their downside is greater, but so is their upside growth potential. For example, if their participation rate is 70% and the S&P 500 increases by 10% over the course of the year, the investor’s rate of return will be 7%. The concept of this type of annuity is that the investor will receive greater gains within their account as major indexes increase but offered with a protection against downturns in the same index. As with any investment, there is capital risk with any participation rate selected.
Indexed Annuities- How the Interest is Calculated
One area which is a bit more confusing than other annuity types is how the interest within these accounts is actually calculated. Interest, or account growth, is calculated based upon the underlying index, participation rates as selected by the account owner, spread or margin, and any interest rate caps as stated by the insurance company.
Equity indexed annuities are considered long term investments and choosing them within your portfolio should be done carefully, with your investable assets, risk tolerance, investment time frame and investment objectives all take into consideration.
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