The mechanics fit on one page if you keep the contract’s order. Money goes in. A term runs. The insurer measures an index the way the contract says to measure it. Limits cut the result. The credit, if any, is added. If you take money out at the wrong time, charges and forfeitures can come off.
Premium goes to the insurer, not into the index
You pay the insurance company. The company does not open a brokerage account in your name that holds the stocks in the S&P 500 or any other index. The SEC’s July 31, 2020 bulletin is clear that the credit is based on the change in an index, and that you are not invested in the index itself. The insurer may buy options or other instruments to support its promise. That hedging is the company’s business. It does not give you ownership of those instruments, and it does not mean the credit will match the index.
Dividends are usually excluded. The SEC’s illustration — a 7 percent total return of which 2.5 percent is dividends, so that many indexed annuities would use 4.5 percent — is a teaching example. Do not treat 4.5 percent as a typical credit. Your contract might use a price index that never included dividends in the first place.
The term, then the measurement
Interest is calculated over a crediting term the contract defines. At the end of the term (or on the schedule the contract uses), the company applies its method. Some methods compare the index on two dates. Some use an average of index values during the term. The name of the method matters less than the worksheet in your contract. Two contracts can cite the same index and credit different interest because they measure the change differently or because they apply different caps, participation rates, or spreads. Those limiters have their own page, with the only numerical examples this site uses: the SEC and FINRA hypotheticals.
A method is not a promise that the renewal will look like the first term. FINRA wrote in 2022 that the insurer may change the limits later. When you read a sales illustration, separate the guaranteed columns from the columns that assume today’s cap continues. This site does not reproduce illustrations and does not know your renewal terms.
A down index, if you do not withdraw
The NAIC Buyer’s Guide (revised 2013) tells consumers that if the index goes down, the interest credit for that period is typically zero, provided you do not take a withdrawal. The account does not get a matching negative percentage from the index in that typical fixed indexed design. Interest that has already been credited is usually locked. Later terms start from the value that includes those locked credits, and then the new term’s formula applies. Locking a credit does not lock the next term’s cap.
Zero is not a gain. Over a long stretch of rising prices for food, housing, or medical care, a series of zero credits leaves you with the same dollar account and less purchasing power. The contract does not promise to match inflation. A zero credit also does not, by itself, refund a rider charge or a previous withdrawal.
Taking money in the middle of a term
The same NAIC guide says a withdrawal in the middle of a term may cause you to forfeit the index interest for that term that has not yet been credited. People hear “you cannot lose credited interest” and then withdraw a week before the term date. Uncredited interest is not credited interest. Ask the company, in writing if you can, what a withdrawal on a specific day does to the current term. Do not rely on a general article for the cutoff time.
A withdrawal can also face a surrender charge, and on some contracts a market-value adjustment. Those are separate from the index formula. You can owe a charge even in a year when the index credit was positive, and you can forfeit uncredited interest even when the surrender charge has reached zero. Read surrender charges before you treat the account as a savings account.
The legal floor is not the sales story
Beside the index formula, deferred annuities are subject to nonforfeiture rules in the state where the contract is issued or delivered. FINRA’s July 14, 2022 article described a minimum guaranteed interest rate, usually 1 percent to 3 percent, on at least 87.5 percent of premium. That sentence is FINRA describing what was usual. It is not a federal statute that guarantees a 1 percent to 3 percent credit on the whole account.
NAIC Model 805, as revised in the fall of 2020, sets out a formula. The interest rate used in that formula is not less than 0.15 percent before an extra reduction the model allows when the contract provides substantive participation in an equity-index benefit. The model is a model. A state may still be on an older floor, or may have adopted different words. Whatever the floor is, it supports a minimum value. It does not tell you what the index method will credit in a good year, and it does not cancel a surrender charge that the law still permits.
Later choices: leave it, withdraw, annuitize, or add a rider
After credits have accumulated, the contract will list what you can do. You might leave the money in and start another term. You might withdraw, and pay whatever charge applies. You might convert the value to a series of payments, called annuitization, which is a different promise from an optional lifetime-income rider. A rider can promise income that continues after the account value is zero, for an extra cost, and that income is not the same as the cash surrender value. The NAIC guide makes the distinction. It does not publish a standard rider fee, and neither does this site. Details are on the income riders page.
If the money inside the annuity is already inside an IRA or a 401(k), the plan’s rules, including required distributions, still apply. The annuity does not usually add a second layer of tax deferral. That is a FINRA point, expanded on the tax page.
A worked example that is not a forecast
Suppose a contract uses one of the SEC’s hypotheticals: a 7 percent cap, and an index change of 12 percent. The SEC’s illustration credits 7 percent, not 12. If the index change in a different term is negative and you do not withdraw, the NAIC’s typical result for this kind of contract is a zero credit for the term, not a negative credit and not a repeat of last year’s 7 percent. Next year the insurer might declare a different cap. Nothing in that paragraph is a historical average. It is two labeled illustrations stacked so you can see that the cap and the floor answer different questions.
Sources
- U.S. Securities and Exchange Commission, Updated Investor Bulletin: Indexed Annuities (July 31, 2020)
- National Association of Insurance Commissioners, Buyer’s Guide for Deferred Annuities (revised 2013)
- FINRA, The Complicated Risks and Rewards of Indexed Annuities (July 14, 2022)
- NAIC Standard Nonforfeiture Law for Individual Deferred Annuities (Model #805)
- FINRA, Annuities