In the 1990s, indexed annuities were introduced. They are gaining popularity among investors seeking safety when interest rates are low or markets are especially volatile.
Indexed annuities are different from other fixed annuities because of the way interest is credited to the annuity's value during the accumulation phase. Indexed annuities credit interest using a formula based on changes in the index to which the annuity is linked. The formula decides how additional interest, if any, is calculated and credited. Typically, a common index, such as the S&P 500, Russell 1000 Index, or the S&P 100, is used, allowing indexed annuities owners easily to track the annuity's changing value. Issuers specify the product's participation rate as a percentage, this is the extent that indexed annuity owners will be "in the market", and closely follows the index's performance. For example, in an indexed annuity with a stated participation rate of 70 percent, if the relevant index goes up 10 percent, the annuity's accumulated value increases 7 percent.
Like other fixed annuities, indexed annuities promise to pay a minimum interest rate, so the rate applied will not be less than this minimum guaranteed rate even if the index-linked rate is lower, and the value of the annuity will not drop below the guaranteed minimum. For example, many single premium annuity contracts guarantee the minimum value will never be less than 90 percent of the premium paid, plus at least 3 percent in annual interest (less any partial withdrawals). To pay for these guarantees, any growth comes with a "spread". The spread is the difference between what the annuity account actually earns, and the amount credited. The annual spread typically ranges from 1.5 percent to 5 percent, and is stated in the initial contract and statements subsequently issued by the insurer.
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