What Is An Indexed Annuity?
There are a wide variety of annuity types, and understanding the differences
among them can be complex. One of the specific classes of annuities you
will run into as you research your options is an indexed annuity. This type of
annuity is a little different and carries a different level of risk than the
average fixed annuity.
How An Indexed Annuity Works
Just as any other annuity, an indexed annuity provides a monthly income
based on a one-time premium deposit at an agreed upon rate. The
difference is that the interest credited on an indexed annuity is calculated
based on the index to which the annuity is linked. While a regular fixed
annuity has an interest rate set out from the beginning in the contract, the
indexed annuity has instead a formula by which the interest is calculated.
There is a minimum guaranteed return on the investment that protects you
from some of the risk involved; however, there is more risk and often a lower
return with this type of annuity due to the caps on returns and fees that are
involved. Still, an indexed annuity can provide better monthly returns than
other types of annuities since the rate fluctuates based on the performance
of the attached index.
With a regular fixed annuity, the interest is set out at an agreed upon rate
from the beginning. However, with an indexed annuity, the return can vary
based on how the index performs and on the contract, which usually
stipulates both a cap on the return amount as well as a fee. For example, if
the index returns at 10%, but you have a 2.5% fee and a cap of 9% on
returns, you would actually see a return of 6.5%. There is usually a
minimum guaranteed return of between 1-3% that ensures you will see
some income from the annuity, but the amount can potentially be quite a bit
higher. Still, the cap on returns means you have a limited potential for
Indexed annuities are a good choice for anyone who is approaching
retirement and needs a relatively low risk investment choice that still offers a
chance at a good return on the investment. They offer the opportunity to get
a somewhat better return than a regular annuity, but may also have a lower
guaranteed return, meaning they do carry a bit more risk.
Your insurance agent can discuss with you the available indexed annuities
and help you to determine whether it is a good choice for you.