Indexed Annuities

The stock market can be a dog eat dog world. Your entire life can be changed, for the good or for the bad with a few clicks of a mouse engaging a single transaction or trade. The reason for this is that investors can achieve a very high ROI on one trade, but the same time, they put themselves in a risk if they make the wrong investment. One wrong investment decision can devastate a business or person financially in the same manner that it can provide high return of investments.

Because of this, a lot of people don’t consider the stock market a worthwhile investment, and even express apprehension and fear towards it. However, recent years has brought the development of new investment products and strategies that can allow you to experience the benefits of returns on your investments without a high risk. One such investment is known as the indexed annuity, and this is a very popular type of investment plan among today’s most reputable investors.

How Does an Indexed Annuity Work

An indexed annuity is a type of contract guaranteed and issued by insurance companies. An individual invests an amount of money, which is called a premium, to get a protection against volatile markets, the potential for investment growth, which is associated to an index (e.g., the S&P 500), and in some instances a guaranteed level of lifetime earnings through optional riders.

How is the return calculated

One part of indexed annuity that’s usually misunderstood is the calculation of ROI. To find out how the insurance company calculates the ROI, it’s very important to learn how the index is tracked, as well as how much of the return of index is given to you.

Index Tracking. The amount of money credited to your account partly depends on how much the index changes. Most insurance companies today use a range of methods to track changes in the index value. For instance, they may use different time periods such as monthly, yearly, or even longer periods of time. It’s very important to learn how the index is tracked because it will have a direct effect on your return of investment.

Return Credited to You. Your return on investment depends on a range of factors (any of which can be combined) such as:

Cap is an upper limit put on the return credited to you over a certain period of time. For instance, if the index returned is 10 percent but the indexed annuity had a cap of 3 percent, you only get a maximum of 3 percent rate of return. A lot of indexed annuities put a cap on your return in return you get protection if the market tanks.

Asset/margin/spread fee is a percentage fee that may be deducted from the gain in the index associated to the annuity. For instance, if an index grows 12 percent and the spread fee is 4 percent, then the gain credited to your annuity would be 8 percent.

Participation rate is how much of the index increase you actually get. For example, if the stock market increases by 8 percent and the annuity’s participation rate was 80 percent, a 6.4 percent return (80 percent of the gain) would be given. Most indexed annuities that come with a participation rate have a cap as well, which in this example would restrict the credited return to 3 percent instead of 6.4 percent.

Bonus is a percentage of the premiums received on the first year and it is added to your contract value. Usually, your bonus amount and any income on your bonus are subject to a vesting schedule that is similar to the surrender charge period schedule. Due to the usual vesting schedule, the bonus may be completely forfeited upon surrender in the first few years of the contract.

Riders are additional features that can be included to the annuity for additional costs, which reduce the return but offer additional contractual guarantees.

How much do indexed annuities cost

Index annuities usually don’t have an upfront sales charge, but there are usually important surrender fees (fees you have to pay if you want to access more that the usual 10% free withdrawal amount before the surrender period ends). Although index annuities are typically sold as “no-fee” products, you may still incur a cost to own these products if you add an optional rider, such as a death benefit or income rider.

Indexing chart

Conclusion

An investor can use index annuities to protect principal and not have to worry about the fluctuating stock market. Indexed annuities will guarantee that the investor will receive back a minimum of the income they have invested, regardless of what is actually happening in the stock market. Because of these benefits, the indexed annuity products and strategies are becoming more and more popular for investors who still want to invest and increase their earning potential without making a huge financial risk.

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