What is an Equity-Indexed Annuity?

An equity-indexed annuity is a type of fixed annuity that credits the annuity based on the changes to the index upon which the annuity is based, as opposed to the set method of credit rate calculation in other fixed annuities. This means that you may get additional interest if the index happens to change in your favor.

Equity-Indexed Annuity (Image: Flickr)

There are a number of safeties associated with equity-indexed annuities. Equity-indexed annuities promise to pay a minimum interest rate decided upon when you purchase the annuity, regardless of whether or not the index-linked rate happens to be lower. You can also rest assured that your annuity will not drop below a certain level, which is generally 90 to 100 percent of the premium paid on the annuity.

At the end of each term, the insurance company adjusts the value of the annuity depending on any index changes. There are a variety of different indexing methods that can greatly affect the value of your annuity. For example, annual reset means that interest is added to your annuity annually depending on how the index compares at the end of the year to the original index. High-water mark indexing compares the values at certain terms, usually at the anniversaries of your purchase of the annuity, and credits you depending on the highest points.

Other factors in the equity-indexed annuity include the participation rate, which is the percentage of the index-linked interest rate that will be credited to your annuity. The cap rate is the upper limit on the index-linked interest rate, which means that your annuity will never be credited anything above the stated rate. Make sure to ask your broker about these various features so you can choose what is best for your individual situation.