We all know with Fixed Index Annuities there is 100% downside protection from market volatility. We also know there are limitations on how much of the upside we are able to receive from the indexes as well. Did you know that most Fixed Index Annuities allow you to lock in your gains annually? The terminology is called “Annual Reset”. This avoids the roller coaster you typically would experience with the stock or bond market or even with a Variable annuity.
Since there are only 100 pennies in a dollar, you might be asking yourself “How are my gains determined?” if I’m giving up a chunk of the upside up for all the downside protection? Today, I’m going to over some of the major strategies you can choose from. Typically, you can mix or match strategies and change them annually. It’s always good to have options!
First we are going to talk about the “levers”. These are what limit your upside. The 3 typical levers: Caps, Participation Rates, and Spreads.
- Caps: Caps are the ceilings you can earn in a specific period. These periods are usually on a monthly or annual basis. Your earning cannot exceed these caps.
- Participation Rates: Participation Rate is simply a percentage of the earning you can pocket. For example, if your participation rate is 50% then you would receive 50% of whatever the index earned that year. If the index returned 10%, you would receive 5% since you get 50% of returns.
- Spread: Spreads are fees that don’t eat into your principal. The insurance carrier gets the spread first and you get what is left over. For example, if the spread is 3% and the index returned 7%, you would then receive 4% because this is what is left over after the spread has been applied.
Secondly, I want to go over crediting methods. Where levers are the limiters on upside potential, you first need a strategy in place to obtain upside gains. These are called Crediting Methods. The more traditional crediting methods are Annual Point-to-Point, Monthly Sum, and Monthly Average.
- Annual Point-to-Point: This method tracks changes in the index from one year to another. You gains are based on the changes from year to year.
- Monthly Sum: Monthly increases and decreases in the indexes are added and subtracted. The sum determines the gains you shall receive that year.
- Monthly Average: Basically, you are collecting index values on the same day over a 12 month period, averaging them together. The % in change from the starting date is you’re earning.
To recap, earnings on Fixed Index Annuity gains are limited and typically you lock in your gains annually. Your upside potential is determined on levers and crediting methods. There is 100% downside protection.