How Do Fixed Indexed Annuities Work?

Think of a fixed annuity as a chunk of your net worth earmarked for growth in the long term (five, seven, or ten years) with no downside risk and with partial annual access to that chunk of money. Just like when you’re comparison shopping for CD rates, normally the longer you lock in, the better the rate. Also consider that some insurance companies give different rates depending on the amount invested, so you could get a better rate by investing more. And the partial annual access means that a small amount, usually 10 percent, of the total investment isn’t subject to the contract term and is available to withdraw if needed. For example, of a $100,000 seven-year investment, you could access $10,000 each contract year.

The insurance carrier will offer a variety of investment buckets within the fixed annuity.

Every contract year, the carrier will offer renewal rates for each bucket. You can change allocations each year in most cases. Let’s examine the different buckets.

• Bucket 1: The Fixed Account – This bucket guarantees a return on your money by simply earning interest. The interest rate is declared annually, and even in negative markets, positive interest accumulates daily.
• Bucket 2: Annual Point to Point – The strategy of this bucket involves using a market index, such as the S&P 500, to earn interest on your investment up to a maximum cap. You can earn from 0 to 6 percent interest if 6 percent is the cap. If the S&P 500 goes up 10 percent, you earn your maximum rate of 6 percent. If the S&P 500 goes down 10 percent, you earn your minimum rate of 0 percent. If the S&P 500 goes up between 0 and 6 percent, you earn that interest rate.
• Bucket 3: Participation Rate – In this bucket, interest is calculated as a percentage of the index growth for the contract year and credited annually without a cap. So if the participation rate is, say, 50 percent of the S&P 500, you earn 50 percent of the return over the one-year term, but not less than 0 percent, even if the market return is negative. So if the S&P 500 has a 10 percent return, you earn 5 percent; if it has a 15 percent return, you earn 7.5 percent; if it has a 4 percent return, you earn 2 percent.
• Bucket 4: Monthly Average – In this bucket, annual credit is based on the average index value for the year relative to the starting value. It has unlimited potential to take advantage of bull markets, but a spread fee that reduces the value of the return usually applies.