Traditional Interest Crediting
Fixed Annuity Crediting, as a contract holder, you earn a rate of interest declared by the issuing company for each year that the contract is open. Fixed Annuity contracts usually have terms from 3-10 years and interest is credited at the contract anniversary.
- Premiums are paid into the contract
- The company invests the money in bonds, mortgages, or other investment grade securities
- The company takes its “spread” from the interest it earns (i.e. the amount of money it needs to pay the expenses of annuity issue and administration and make a profit)
- The company credits the declared rate of the interest to the contract
Fixed Indexed Annuity Interest Crediting
In a Fixed Indexed Annuity, the same process is followed but remember that there are two baskets, a fixed account and index account. Most deposits throughout the year will be automatically per company policy placed into the fixed account until annual asset allocation.
- Premiums are paid into the contract
- The company invests the money in bonds, mortgages or other investment grade fixed income securities
- The company takes its “spread” to cover costs and profits
- Floor rates and Cap rates ensure you a set boundary of interest that can be earned
What changes between these two annuities, is what the company does with the balance of its portfolio interest earnings after taking its spread. In a Fixed Indexed Annuity, the company takes the balance of its interest earnings — which in a traditional Fixed Annuity would be credited as “declared interest” — and negotiates and invests them in customized index options designed to match the index crediting formula. This should provide a better rate of interest over the course of the Index Term. Earnings from these index options are then used to credit the indexed interest to the annuity. Below is a hypothetical example of how this works.
Fixed Index Annuities can be a valuable financial vehicle for retirement savings. They offer the safety and guarantees that clients expect along with growth opportunity to help your retirement savings keep pace with inflation. Fixed Index Annuities provide peace of mind by offering:
- Tax Deferral
- Full Accumulation Value at Death
- Liquidity Options
- Ability to Avoid Probate
- Lifetime Income Options
- Fixed Account Option
Daily Average strategy can be beneficial when the markets are volatile, like the past 7 years. It can smooth out market highs and lows because Interest Credits are linked to the average daily performance of selected external market indices. Credits, if any, are measured each contract year and are based in part on the value of the respective index over that same term.
It is important to remember that the credits received WILL NOT mirror the performance of the chosen index option(s). The daily average is calculated by subtracting the Beginning Index Value from the Daily Average Index Value. The Daily Average Index Value equals the sum of the index values over the contract year, excluding the Beginning Index Value, divided by the number of index values available for the contract year. The Beginning Index Value equals the index value on the first day of the contract year.
The difference is then divided by the Beginning Index Value, this amount is called the percent of index change. This value can either be positive or negative. Once the percentage change is determined it will then be subject to either a Participation Rate, Index Cap Rate or a combination of any of the above. The resulting final value will be the amount of interest credited at your contract anniversary.
Regardless of market performance, Interest Credits can never be less than zero. To illustrate, if the Interest Credit is calculated at 0% or a negative amount then you will receive 0% Interest Credit for that contract year. Interest Credits will only be added using this strategy at your contract anniversary. Once added, credits will be “locked in” and won’t be affected by possible future negative index performance.
Fixed Indexed Annuities may offer an Annual Reset feature or provision that may increase the contract owners value in a number of ways.
- The provision allows an Index Credit to be added to the Index Account on each anniversary. Once added, this Index Credit is “locked-in”, and can never be taken away due to possible future negative index performance.>
- The Index Credit that was added to the contract owner’s initial premium now becomes the guaranteed Index Account “floor” which participates in all index crediting going forward. This new amount will participate in future Index Growth, giving the client the advantage of compounding.
- The index starting point is reset each year at the contract owner’s anniversary. This is beneficial when the index experiences a severe downturn during the year. The contract owner can take advantage of gains from that point forward. Without the Annual Reset Provision, the contract owner would have to wait for the index to climb to its original level before any gains could be realized.
Who is the ideal customer for the Annual Reset?
- The ideal prospect for annual reset is one who normally purchases a traditional fixed rate annuity, but is looking for the possibility of higher returns without additional risk due to market downturns. While an annual reset product is an excellent alternative for a prospect who purchases variable annuities, stocks or mutual funds, it is not intended to replace these retirement vehicles. A prospect should not expect an annual reset product to mirror the performance of any stock market index. Again, it is for the individual who is looking for the potential for higher returns on a guaranteed vehicle.