Understanding Your Equity Index Annuity's Index Method

Investing in an equity index annuity can provide you with exposure to the market and some safety at the same time. Because of these features, many people invest in this type of investment for their retirement planning. The profits from this type of investment can be affected by many different things. One aspect that can affect the return is the method that is used for indexing.

Index Method

The basic idea behind all equity index annuities is the same. You are going to be putting money into an annuity and your returns are going to be tied to a financial index. If the financial index does well, the money in your account is going to increase. If the index performs poorly, it is going to decline in value. However, the way that the company calculates the change in the index can be extremely important. This is known as the indexing method and it can make a big difference. There are many different indexing methods that could be used by the insurance company.

Annual Reset

One method that many companies tend to use is the annual reset method. This method is also referred to as the ratchet method. With the annual reset method, they are going to compare the change in the index from the beginning of the year to the end. This is one of the simplest ways to calculate the percentage change in the financial index. Most of the time, they are not going to make any changes if the index declined in value. Many investors like this method because it allows them to take advantage of locking in their rate despite what the index may do the rest of the year.

High Water Mark

Another method that can be used is the high water mark. With this method, they are going to look at the highest point in the market and compare it to what the rate was at a specific point in your contract. For example, many of these policies will compare based on when you started your policy.

Point-to-Point

The point-to-point method is another method that could be used to determine the percentage gain in your annuity. With this type of index method, they are going to choose two points and then compare the difference between these two points. For example, they will look at the rate that was present in the market on the day that you opened your annuity and the day that the contract ends. They will calculate the percentage difference between those two dates and that is the amount that you will earn in your annuity.

Averaging

Some equity index annuities also use an averaging strategy. With this type of strategy, they are going to average out the value of the index on a daily basis. By doing this, they are going to limit the amount of interest that you can earn in your equity index annuity. 

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