Traditional fixed annuities pay interest on the premium contributed at a rate declared by the insurer in advance.
A buyer does have an option to elect a declared interest rate, which generally allows an allocation of anywhere from 0-100% of the account value, and functions the same as a traditional fixed annuity.
However, the annuity is designed for higher potential interest rates, and provides other allocation options which consider the performance of an outside stock index (such as the Standard and Poor's 500, a.k.a.
For instance, if a particular index crediting method offers a 6% cap, and the calculated return was 10% for the year, the policy would earn a rate of 6%.
A "spread" is a percentage of reduction between the calculated return and the interest rate the consumer will be credit with.
All participation rates, caps and spreads are set by the insurance company at the beginning of a policy.
Most annuities being issued today have only one moving part in determining an index calculation (i.e. only a cap or only a participation rate), however, it is possible to have multiple moving parts in determining an index calculation (i.e. a cap combined with a participation rate).
The "annual point-to-point" method determines the value of the index on issue date of the policy and compares it to the value of that index on a date in the future (generally one year later) to determine the calculated return.
As required by state insurance law, indexed annuities do provide for a minimum amount of interest.
These products may also waive surrender charges if the policy is annuitized (converted into an immediate annuity that would generate income payments over a specified period of time which is elected by the policyholder).
An "income rider" generally will provide a specified accumulation rate which is guaranteed for a certain period of years.
Each time an income payment is paid to the policyholder, the indexed annuity account value is decreased by that same amount.
As with all traditional fixed annuities, money can be withdrawn from an indexed annuity at any time (but such withdrawal may be subject to a surrender charge if the policy is still within the surrender charge period and the penalty-free withdrawal has already been exhausted).
Owners may also choose to receive a payment based on the value of the policy for their lifetime (called annuitization).
[9] In the event of the owner’s (and the annuitant’s in some policies) death, the beneficiary of the contract usually receives any remaining value in the policy, and if the annuity had been annuitized and additional guaranteed payments remained, subsequent annuity payment would be made to the beneficiary at the same intervals the deceased was receiving them until the guaranteed period has expired.
[11] There are 44 different insurance companies offering indexed annuities today [12] On January 16, 2009, the Securities and Exchange Commission (“SEC”) issued Rule 151A claiming indexed annuities should be regulated as securities and should only be sold by registered representatives.
[13] A lawsuit was filed on the same day challenging the SEC’s ability to regulate fixed indexed annuities.
[14] On July 21, 2010, President Obama signed HR 4173 (Dodd-Frank Wall Street Reform and Consumer Protection Act) which contained a last minute amendment by Senator Harkin (“Harkin Amendment”)[15] which exempted fixed index annuities from regulation by the SEC and left these products to be regulated by the state insurance departments.