Equity-indexed annuities is a type of hybrid between the fixed annuity and the variable annuity. The fixed annuity is a low-risk investment, but you will not be able to benefit from a growing financial market. With a fixed annuity, the value growth of your annuity will be based on a pre-determined rate regardless of the overall market performance. With a variable annuity on the other hand, the investments will have a direct impact on the value of your annuity. This will however also mean that you will loose your money if those investments turn out to be bad choices. With most variable annuities you can not even be sure to get your invested money back, since the value of your variable annuity can drop below the initial purchase value. The Equity Indexed Annuity (EIA) is a way of combining the potentially high growth rate of the variable annuity with the comparative safety offered by the fixed annuity. An Equity Indexed Annuity will be linked to a chosen index that reflects the growth of a particular stock market, such as the Dow Jones Industrial Average or the S&P; 500. An Equity Indexed Annuity will also typically be sold with a value guarantee which means that the value of your annuity will never drop below your initial purchase value, or below a certain percentage of your initial purchase value. A large part of the Equity Indexed Annuities will even offer a minimum interest rate. A very common form of standard Equity Indexed Annuity offers at least 3% in annual interest and the value of the annuity can never drop below 90 percent of the purchase value.
Equity Indexed Annuities will use different formulas to calculate the value of the annuity in relation to the changes in the chosen index. Since different Equity Indexed Annuities use different formulas, the amount of additional interest and how this interest is paid out can vary significantly between different Equity Indexed Annuities even if they are linked to the same index. The indexing method and the participation rate for your Equity Indexed Annuity are two factors that will be of vital importance for you and that you should understand before you decide which Equity Indexed Annuity to purchase.
Three of the most common indexing methods are the Annual Reset, the High-Water Mark and the Point to Point. All three methods are used to measure how the index has changed and how this should affect the value of your Equity Indexed Annuity. If you purchase an Equity Indexed Annuity that uses the first method, the index value at the end of the contract year will be compared with the index value at the beginning of the contract year. If the value from the end of the year is higher than the value from the beginning of the year, you will earn interest on your Equity Indexed Annuity and the size of the interest will depend on the increased value. If you instead choose an Equity Indexed Annuity that uses the High-Water Mark method, the interest on your Equity Indexed Annuity will be determined by comparing the index value at the start of the term with several index values from various times during the entire term. The difference between the best index value and the initial index value from the beginning of the term will determine the interest rate for your Equity Indexed Annuity. With a Point to Point method, the interest on your Equity Indexed Annuity will be determined by the difference between the index value at the last day of the term and the index value at the first day of the term.