- Hey everyone!
Will Lethemon here for Moneyevolution.com.
And today's video blog,
I'm gonna be talking about:
How does an Index Annuity work?
So first of all, lets talk
about what is an Index Annuity.
Well an index annuity is really
just a type of a fixed annuity,
where instead of getting an interest rate
from the insurance company,
the interest rate that you receive
is going to be based off
of your participation
in an underlying index,
like maybe the S&P 500.
I know there's a lot of people out there,
that refer to these as hybrid annuities.
Hybrid annuity is really
not an official term,
but I know a lot of people out there
who refer to them as that.
So if you see the terminology hybrid,
this is usually what they're referring to.
Now there's gonna be
two important components
to an index annuity, that
we're gonna talk about here.
And the first one is going to be
the Interest Crediting Method.
And lets talk about
that here just a second.
And again lets use the example
of the Standard & Poor's 500.
So lets say that, that is
the index that you choose.
And depending on the annuity,
you might have a number
of different indexes
that you can pick and choose from,
that can range from portfolios or indexes
that might be 100% stock based,
to portfolios that might have
a mixture of stocks and bonds.
There's a couple of things
that are gonna be important
to look at though.
One is what is the crediting method,
and how is your interested going to be
accumulated every year.
And that's usually going to be done
with either , what's referred
to as, a cap, or a spread.
And again, lets say were
using the S&P 500 here.
And so a cap would be an upper limit to
how much you're able to
make within that annuity.
So if we have a cap rate of 5%,
what that means is that
if the S&P 500 goes up,
whether it's 2%, or goes up 5%,
you can make up to 5% with that.
But if the index goes up 7%, or 17%,
the most you could make
would be a 5% return on that,
because that's the cap,
or if you think of it
like the upper ceiling.
The second way they do that.
And that's what is gonna
be, we'll call that cap.
And the second thing is going
to be what is referred to as spread.
And a spread is an amount
that would get deducted from
that indexes return, before
your interest is credited.
So, the example the same, the S&P 500
and it had a spread of 2%,
and just to clarify here,
I don't know any annuities
in this market place,
that have a spread of 2% on the S&P,
usually we're seeing things
come in around 5% for a cap.
But anyway, lets just go with that,
cause it'll keep this
example rolling here.
So if we had a spread of
2%, and the index returned
at 10% rate of return for the year.
We would subtract that 2%,
and the interest that
you would get credited,
would be 8% for the year.
So, some index annuity have
a cap, some have a spread,
some might even have a cap and a spread,
where it might subtract
something from the annuity,
but you can still only make
up to a certain amount.
Now, how this works is, lets say,
that you started off with a
$100,000 in your index annuity,
and lets say were using an S&P 500,
with a cap of 5%.
If this year, the return
on the S&P 500 was 4%,
then the value of that
account at the end of the year
would be $104,000.
Lets say the next year, the market tanks.
And whether it goes down
10%, 20% or even 50%,
the worst that you can
do, in a year, would be 0.
Because from one point to another,
you are principle is
essentially protected,
within the annuity.
That's one of the main benefits
of this type of annuity,
is that your money is generally
pretty safe with this.
The following year, lets
say the market does 12%.
Well, we can only make 5%,
because that's our cap,
and I'm running out of room here,
but you get the idea,
that you can make 5%.
And this can go on like this for quite
a long period of time,
as long as you keep that
money in the annuity,
you're gonna continue getting
that upside potential.
So a couple things on that,
so the crediting method,
whether you have a cap or a spread,
what index you're choosing,
and then the other factor
that's gonna be in there
is the term. So most often
we see the S&P 500 indexes,
with a one year point to point,
which means from the day that you start,
until basically that same
day the following year.
They're gonna take a snapshot,
what was the S&P at the
beginning of the period,
and what was it at the end.
And if it was positive,
they're gonna calculate out that interest,
and credit it that to your account.
Some indexes might be a little bit longer.
You might have a two year,
or a three year index,
which means there's
gonna be point to point
over a two or three year time period.
So you wanna keep that in mind.
The second thing that we wanna look at,
is a feature here, with that
the interest crediting method
and I'm gonna put this over here,
is there might be an
income or withdraw feature,
to the annuity.
So again, one of the reasons
that a lot of people
look at buying annuities,
is they want this for an income
stream or a withdraw stream,
that they can take out for themselves,
most likely in retirement.
And depending on the annuity,
there's some fairly decent
features to some of these.
It's gonna be dependent
on a couple of factors.
One is gonna be, your age,
generally the older you are
when you start taking income,
that's gonna give you potentially
better withdraw rates.
For example, it might be
4% if you take the income
beginning at age 60, it might go up to 4.5
if you wait until age
65, just as an example.
Whether you do it joint,
or single life,
so if you wanna have the income guaranteed
for as long as either you
or your spouse are alive,
that would be a joint benefit,
and obviously that's
gonna reduce that amount.
So you might get again,
4.5% if its just based off of your life,
but it might drop to 4% if you want to
guarantee it over you and
your spouses lifetime.
And also, to the final thing might be
the number of years that you wait
before you start taking that income.
So if you invested that money
into the annuity at age 60,
but you waited until age 65
to start taking those
withdrawals or that income,
some annuities have a feature,
that will give you an automatic increase
in what that future withdraw
or income benefit might be.
So that would be the
final feature with that.
So lots of different moving parts
within this type of annuity.
So be sure to do your homework,
and to really make sure you understand
all of the intricacies of the annuity,
that you're looking at doing.
And one thing I was
gonna think about here,
is this income feature
often has a Rider Cost.
And that cost could
be, maybe anywhere from
a little bit less than a percent,
it could be a little
bit more than a percent,
so that would be something that
would come off of the value,
so even in one of those years,
where maybe the market went sideways,
you still might see a little bit of a drop
if that one percent were
to come off of that.
So just to be clear on that,
I wanted to point that out as well,
there could be a Rider Fee
in there for some of those.
Some of them, they don't
have an income feature,
don't have a Rider Cost,
and really there's no cost at all,
other than what's built into
either those caps or those spreads.
So this is gonna be
part of a video series,
I've already got, I think,
several videos up on our Youtube channel,
under an annuity playlist,
so if you haven't seen
some of those other videos,
check those out and as
more topics come up,
we'll continue to probably
add to that playlist.
Check that out, if you have questions,
feel free to call us.
We can either review or
walk you through an annuity
that you may already own,
or we can answer
questions about an annuity
that you're thinking about buying.
Or if you wanna see how
an annuity might fit
into your retirement portfolios.
So anyway, that's it.
I hope you enjoyed this video.
Check out some of our other
stuff on Moneyevolution.com
I will see you back at
our next video, thanks.
