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How do annuities make money?

Annuities are popular retirement planning vehicles where a large principal payment is held with an insurance company in exchange for regular sums paid out over a predetermined period of time. With their focus on steady income generation, fixed annuities can be a very valuable component to a retirement portfolio. A fixed index annuity is a twist on this traditional style; in addition to earning a baseline fixed interest rate over a fixed term with principal guarantees, alternative also includes a market-based growth component to annuity earnings. Thus, along with the base contract rate agreed upon in an annuity contract, these insurance products can also earn extra value when the market performs well. By tracking indices like the S&P 500, a fixed index annuity can provide more earning potential when times are good, and will earn the minimum guaranteed rate––without risking principal––should market downturns occur.

Crediting Methods

In order to determine the interest earned in each period, insurance companies use one of several different crediting, or calculation, methods. In many cases, the chosen method is outlined in the annuity contract and is consistent throughout the life of the annuity, but others permit more flexibility, providing the opportunity for changes or adjustments on a semi-regular basis. With a basis in overall market movement, each crediting method has pros and cons depending on overall economic activity.

Annual Point-to-Point

Annual point-to-point crediting accounts for growth based on the amount of interest earned on market gains over the course of a 365-day period. Generally, this amount is limited based on the annual cap specified in an annuity contract; for example, if annual interest gains are at 12% and an annuity’s cap is 10%, only 10% will be credited. This method is best in times of high volatility, when markets may rise and fall over the course of a year but still maintain a strong likelihood for net positive growth in an annual period.

Monthly Point-to-Point

Monthly point-to-point crediting relies on monthly index performance rather than annual and is subject to the outlined monthly cap applicable for an annuity. At the conclusion of each year, each month’s returns are added up and applied to the balance of the account, assuming positive overall performance for the year. This method is best for months or annual periods that are steadily on the rise.

For more see >> Point to Point Annuity Crediting Method

Monthly Average

The monthly average approach takes the average of 12 months of growth in order to determine the mean value for the year. This growth is the applied to your principal, contributing interest income to your annuity. In general, there is a cap on gains with a monthly average method, like most other annuity crediting methods. With strengths in periods of measured volatility that will likely yield a positive outcome, the monthly average method can still provide a payout in years with significant shifts.

For more see >> Retirement Annuity Monthly Average Crediting Method

If you are seeking a way to provide guaranteed income in the future without sacrificing the potential for growth, a fixed income annuity may be the perfect addition to your portfolio. By incorporating index tracking into your annuity portfolio, you are able to take advantage of market activity without the risks that accompany traditional asset accounts, offering stability, consistency, and growth potential throughout retirement.

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