MY INDEXED ANNUITIES Flashcards
What are Equity-index Annuities?
Equity-index annuities are annuities that provide a return based on a stock index. The return on the index is used in calculating the return credited to the product at the end of the calculation period. The most commonly used index is the S&P 500 Composite Price Index. This index represents many different industry groups. The major industry groups represented include industrial, utilities, financial and transportation.
Although many insurers use this index, the return on equity-index annuities varies from company to company based on the features and benefits included in the contract and on the method of calculating the index return.
Regarding Equity-index Annuities, what is a “cap”?
The “cap” is the limit on a percentage increase from one return period to the next in some equity-index annuity contracts. If a contract includes a cap, when the return on the annuity is calculated, the new return cannot increase by more than the cap percentage.
Regarding Equity-index Annuities, what is “Term”?
Term
The “term” of the equity-index contract is the contract length. These products may have terms in a variety of lengths, from one to ten years. For example, an equity-index contract may have a six-year term. After the six-year term, it may be renewed for one-year periods. During the initial term, surrender charges generally apply to withdrawals or surrenders. Surrender charges do not generally apply during a renewal term.
Regarding Equity-index Annuities, What is “Vesting”?
Vesting is another way of applying a surrender charge to an equity-index annuity contract. Rather than applying a specified surrender charge percentage to the cash values withdrawn or surrendered during the policy term, a contract that includes vesting does not make the entire cash value of the contract available for withdrawal until the end of the policy’s term.
Example:
Imagine you have a special savings account. 🏦
Equity-Index Annuity Contract: Think of this like a fancy savings plan. You put money into it over time, and it grows based on how well the stock market performs. 📈
Surrender Charge: Uh-oh! If you want to take out your money early (before a certain time), there’s a fee. It’s like a penalty for breaking the savings plan. 😬
Vesting: Now, here’s the twist. Some savings plans have “vesting.” It means they don’t let you take out all your money right away. Instead, you have to wait until the end of the plan (like a game with a finish line). 🏁
Example: Imagine you put $1,000 into your special savings account. With vesting, you can’t just grab the whole $1,000 whenever you want. Instead, they give you a little bit at a time. Maybe after a year, they let you take out $200. Then after two years, another $300. And so on. 🕒
Why Vesting?: It’s like a rule to encourage you to stick with the plan. If you’re patient and wait until the end, you get the full amount. But if you rush, you might lose some money due to the surrender charge. 🤔
Remember, vesting is like a game where you collect your savings over time, and the finish line is when the plan reaches its end.
Regarding Equity-Index Annuities, What is the “Participation Rate”?
The participation rate refers to the percentage of change in the index that is used in the return calculation. For example, if the participation rate in a contract is 80% and the index increases by five percent, the most the rate of return may go up is 4.00 percent.
The participation rate is allowed to be changed by the insurer under certain contracts, within a certain range, at each rate change period. Some contracts also offer a kind of bonus rate during the first year of the contract; the participation rate in a contract with a “bonus” may be 110% of the index, for example.
Let’s break down the concept of “participation rate” using a simple example:
Imagine you’re playing a game where you get to ride a roller coaster. 🎢 But instead of going up and down, this roller coaster represents the stock market. 📈
The Roller Coaster (Stock Market): The stock market goes through ups and downs. Sometimes it climbs high (like when your favorite team wins), and other times it drops (like when you lose your favorite toy). 📉
Your Participation: Now, you decide to join this roller coaster game by investing some money. You put your savings into an equity-index annuity contract. This contract is like a special ticket that lets you ride the stock market roller coaster. 🎟️
The Participation Rate: Here’s the twist! The contract has something called a participation rate. It’s like a rule that says, “Hey, you won’t experience the full roller coaster ride.” 🚫
Example: Let’s say your participation rate is 80%. If the stock market (our roller coaster) goes up by 5%, you won’t get the full 5% ride. Instead, you’ll only get 80% of it. So, your return would be 4% (80% of 5%). 🎢
Why the Limit?: The contract does this to keep things fair. It’s like saying, “We won’t let you enjoy the entire roller coaster thrill because we want to protect you a bit.” 🤷♂️
Bonus Round: Some contracts are extra fun! They offer a bonus rate during the first year. Imagine it’s like getting a free cotton candy at the amusement park. 🍭 These contracts might give you more than 100% participation (like 110% of the stock market’s movement). So, if the market goes up, you get a little extra joy! 🎉
Remember, the participation rate is like a seatbelt on your roller coaster ride—it keeps you safe but limits the excitement a bit! 😉
Regarding index annuities, what is “Floor”?
The minimum index-based rate the insurer will pay on an equity-index annuity is referred to as the “floor” in many contracts. If the contract has such a provision, the floor is generally 0%. If a contract has a floor of 0%, the insurer will never credit a negative amount of return to a contract.
Example:
What Is a Floor?
In indexed annuities, the floor is a protective feature that limits your risk as the buyer.
It represents the minimum index-based rate that the insurer guarantees to pay you, regardless of how poorly the chosen stock market index performs.
How Does It Work?
Imagine you have an indexed annuity linked to the S&P 500 index.
If the S&P 500 performs well during a specific period, your annuity earns interest based on that positive performance.
However, if the S&P 500 performs poorly (or even goes negative), your floor ensures that you won’t lose beyond a certain point.
Example:
Let’s say your indexed annuity has a floor of 3%.
If the S&P 500 index underperforms by 6%, you’ll only lose the 3% that isn’t protected by your floor.
In other words, your annuity won’t credit a negative return; it will at least maintain the floor rate of 3%.
Protection Against Loss:
The floor acts as a safety net, shielding you from significant losses during market downturns.
While it limits your upside potential, it provides peace of mind by preventing negative returns.
Remember that indexed annuities strike a balance between potential gains and risk mitigation, making them suitable for those seeking moderate risk tolerance and longer-term investments.
Regarding index annuities, what does the term “averaging” mean?
“Averaging” is used in the calculation of the index-based return in some equity-index annuities. The change in the index is averaged over a specified period, for example, monthly or annually, and the result is used in the index-based return calculation.
What Is Averaging?
Averaging is a method used to calculate the index-based return in some equity-index annuities.
It involves taking an average of the index’s values over a specified period (such as monthly or annually).
How Does It Work?
Imagine you have an indexed annuity linked to the S&P 500 index.
Instead of directly using the index value on a specific date (like the anniversary date), the insurer calculates the average of the index values over a period.
This average is then used to determine the annuity’s interest or return.
Example:
Let’s say you purchased an indexed annuity on December 31.
On that day, the S&P 500 index was valued at 500 points.
Instead of using this exact value, the insurer might calculate the average of the S&P 500 index values over the entire year.
If the average over the year is 550 points, your annuity’s return would be based on that average rather than the specific value on December 31.
Why Use Averaging?
Averaging helps smooth out index performance.
It ensures that interest is not credited based solely on the index’s highest or lowest point.
While it limits potential gains, it also provides stability and reduces the impact of short-term market volatility.
Remember that understanding how averaging works in your specific indexed annuity contract is essential to make informed decisions about your investment.
Regarding index-annuities, what does the term “compounding” mean?
Some equity-index annuities compound returns during the policy term. If compounding is used, the earnings from one rate calculation period are added to cash values before the next earnings rate is applied. Some equity-index annuities do not compound earnings, and so use premiums contributed to the annuity only when calculating earnings at the end of a calculation period.
Let’s break down the concept of “compounding” in the context of indexed annuities:
What Is Compounding?
Compounding is like a snowball effect for your money. It’s when your earnings generate additional earnings over time.
In financial terms, it means that the interest or returns you earn on an investment are reinvested, leading to exponential growth.
Indexed Annuities and Compounding:
Some equity-index annuities use compounding during the policy term.
Here’s how it works:
You contribute money (premiums) to the annuity.
During each rate calculation period, the annuity earns returns based on an index (like the S&P 500).
If compounding is used, the earnings from one period are added to your cash values before the next earnings rate is applied.
This means that not only do you earn returns on your initial investment, but you also earn returns on the accumulated earnings.
Over time, this compounding effect can significantly boost your annuity’s value.
Example:
Let’s say you have an indexed annuity with a compounding feature.
You contribute $10,000 as your initial premium.
During the first year, the index performs well, and your annuity earns a 10% return.
With compounding, your cash value becomes $11,000 ($10,000 + 10% of $10,000).
In the second year, the index performs even better, earning another 10%.
Now your cash value grows to $12,100 ($11,000 + 10% of $11,000).
The process continues, and your money compounds over time.
No Compounding:
Some annuities don’t compound earnings. Instead, they calculate earnings at the end of each calculation period based on the premiums contributed.
In this case, you won’t benefit from the snowball effect of compounding.
Remember that compounding can be a powerful tool for long-term growth, especially in investments like indexed annuities.
Regarding index annuities, there are generally 3 index benefit calculation methods. What are they?
There are three index benefit calcutaion methods that are generally used by insurers offering equity index annuities. An insurer is likely to use one of these methods, or to use a calculation method quite similar to one of these methods. These are (1) the “annual reset method,” (2) the “high-water mark method” and (3) the “point-to-point method”.
What is the Annual Reset Method
Annual Reset Method
The annual reset method is sometimes referred to as the “ratchet” method. When this method is used, the index value at the beginning to the end of the year is compared. Declines are ignored when the calculation results in a negative number. In a situation where a negative number is the result of the calculation, 0% is credited, not the negative number. The insurer may apply caps and participation rates to the change in the index.
For example, the S&P 500 was at 1210 the day Mary opened her equity index annuity contract. At the end of the contract year, when the calculation is to be made, the S&P 500 is at 1431.
1431-1210 /1210
= .10 or ten percent
The participation rate for the product is 80%. The cap is 10%. The amount credited is 8%. (80% of 10% = 8%)
What is the High Water Mark Index Benefit Calculation?
High Water Mark Index Benefit Calculation
The high water mark index benefit calculation method looks at the index value at specified periods during the contract’s term, such as on the contract anniversary. If the index is higher, then the benefit calculation is performed based on the average return over that year and earnings are calculated. If the index is lower, no calculation is performed and the annuity value remains the same in that year.
Some policies do not actually credit the earnings to the policy until the end of the term. So, if the policy is surrendered before the end of the term, earnings are lost. They may be credited according to a vesting schedule, so that a portion of the earnings calculated under the high water mark method are credited and available should the policyowner cancel the contract.
High Water Mark Example
For example, assume Mary opens a contract with $100,000 and the S&P 500 is at 1200 at this time. The contract has an 8-year term, an 80% participation rate and no cap. The index is reviewed on an annual basis to determine interest crediting.
What is the Point-to-Point Index Benefit Calculation?
Point-to-Point Index Benefit Calculation
When the point-to-point index benefit calculation method is used, the index value at the end of the term is compared to the index at the beginning of the policy. These policies do not credit earnings during the policy term. They are designed for those who will not be making any withdrawals during the term, and so should not be offered unless the consumer has sufficient resources to put money into the annuity and leaving it there for the term of the contract. The term on a contract that uses a point-to-point index benefit calculation is usually shorter than under contracts using other methods.
Assume Mary has opened an equity index annuity with $100,000, the policy term is five years, the contract uses the point-to-point method, has a 2% minimum annual guaranteed return and has no participation rate. The index value at the beginning of the policy term is 1200.
ANNUITIZATION: What are fixed annuities?
Fixed Annuities – Fixed annuities are products that have a guaranteed rate for fixed periods of time. Upon annuitization they offer a variety of payout options.
ANNUITIZATION: What are deferred fixed annuities?
Deferred Fixed Annuities – Deferred annuities have an accumulation period where the contributions made to the annuity accumulate earnings paid by the insurer. The earnings are taxed only when they are withdrawn.
ANNUITIZATION: What are single premium annuities?
Single Premium Annuities – A single premium deferred annuity (SPDA) allows only one contribution to be made to the contract.
