Index annuities with lifetime income riders are frequently referred to as hybrid annuities.
These types of annuities will have account values, and benefit values. The account values will grow subject to caps, participation, and crediting methods used to gauge the performance of the underlying index.
Understanding Index Annuity Crediting Methods:
Index annuities use various crediting methods to determine the amount of the underlying index gained that is credited to your account value. There are actually hundreds of different methods that companies use, so comparing apples to apples among companies can be very difficult. when you consider an index annuity, you should be sure to look at an illustration based on historical market performance to see how the annuity performed based on actual historical data.
As we all know, future market performance may not look like past market performance, however the past is a good guide to understand how the crediting method will affect your account value.
The primary methods for calculating account value are as follows:
Annual reset – This is one of the more familiar methods. Quite simply, the value of the underlying index at the beginning on the contract is compared to the index value one year from that date. Gain is credited to your account value based on the percentage increase (if any) in the index. The same procedure is followed in each succeeding year of the contract. in years where there is no gain on an annual basis, your contract may have a guaranteed minimum rate which will be credited.
Point-to-point – The value of the index at the beginning of the contract is compared to the value at the end of the contract term. Interest is credited only once, based on the percentage increase between those two points. Most commonly, you will see “Annual Point To Point” in contract documents.
High water mark – Gains are credited only once, at the end of the contract, based on the percentage increase between the beginning index value and the highest index over the course of the contract term.
Averaging – With averaging, index values taken at different points over the course of the contract and averaged. These points may be daily, monthly or yearly. Interest can be calculated and credited based on the difference between the beginning index value and the averaged value. This can be done monthly, yearly or at the end of the contract.
What About Caps and Participation Rates?
In addition to the crediting methods, index annuities and account values may be subject to caps and participation rates. A cap is nothing more than a ceiling on the rate of appreciation you will be credited with in any given year or month.
For example, if the crediting method determined that the index increased by 10% in a given year, and your contract is subject to an annual 8% , you will be credited with 8%.
A participation rate is a similar calculation. If you have an 80% participation rate in the market index increases by 10% according to the crediting method, you will be credited with 8% gain to your account value.
Crediting method, Caps, and Participation Rate all work hand-in-hand to determine the rate of appreciation in your account value.
What is the Best Index Annuity Crediting Method?
This is impossible to answer simply because we do not know what the market will do in future years. There will always be trade-offs between you and the insurance company based on the amount of benefits in your contract. If there are many riders like lifetime income, home healthcare, and disability, these are all insurance protections and need to be paid for. Consequently, it is quite likely the insurance company offering these benefits will have low participation and Caps on your account.
Alternatively, if you are looking for an index annuity with the maximum market gain potential, you should eliminate the insurance components of the contract and focus on participation rates, and choose a crediting method that allows for the most potential gain.
The high watermark locks in the highest point of the market in a given year. This has the most exposure for the insurance company, so most likely it will be paired with a low participation rate.
In steadier markets, the point-to-point crediting method may produce higher credits to your account value as gains from one month to the next can be locked in.
In very volatile markets, averaging smooths out the swings, however negative periods can also dilute gains from positive periods.
Determining the best annuity and finding the optimal crediting method for you requires looking at several different contracts and comparing the pros and cons of each. Allow the experts an Annuity Ace to assist you in this decision process.