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What Is An Indexed Annuity

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.

Calculating Interest

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.

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