**Equity Indexed Annuities**

As promised, we are now going to discuss equity indexed
annuities in more detail.

**Recognition of Interest**

The amount of interest an equity indexed annuity earns
primarily depends on how well the tracked index performs during the
year. Obviously the equity index has to show a gain in order for the
annuity to earn money, but how and when earnings are credited to an
annuity account is also very important.

Basically indexed annuity earnings are calculated by
the annuity's indexing formula and by interest recognition periods.

**Indexing Formula**

The annuity's indexing fromula determines how much interest
the annuity can earn based on the performance of the equity index.

So let's say so far this year, the S&P 500 index
has shown a net increase of 15%. In theory, 15% interest would then
be credited to the equity indexed annuity.

However, in the real world, insurance companies will
limit gains paid to equity indexed annuities in order to protect themselves
from possible losses. Remember that one of the good things about equity
indexed annuities is the investor will not be credited with losses when
the index loses money.

So to limit the amount of gains paid to annuities, equity
indexing fromulas use interest ceiling and participation rates.

**Interest Cap**

Most indexed annuities have an interest ceiling or
cap, which limits the maximum amount of interest earned.

For example, if the S&P 500 has a really good year
and makes 15%, but the cap in your annuity is 12%, than your account
would be credited with 12% interest.

If you have trouble understanding how this works you
can think of it this way, the insurance company pays you only a portion
of its earnings from the stock market in order to offset its losses
when the market goes down. So even though your annuity doesn't share
in all of the gain, you don't have to absorb any of the stock market
losses.

**Participation Rate **

Closely related to interest ceiling is another limiting
factor called the participation rate. This is the percentage of the
gain you are actually eligible for before the ceiling limit is applied.
So the formula would be Gain % x participation rate %, not to exceed
the ceiling amount.

For example, say you have a 90% participation rate and
the S&P 500 had a 15% gain so your annuity would be eligible for
13.5% gain subject to the ceiling limit. If the annuity cap was 12%,
then you would get 12% interest for the year.

So if you want to maximize gain in your equity indexed
annuity, you are looking for a high participation percentage and a high
ceiling cap. However be aware that you may have to accept a lower floor
or even participate in losses to maximize your gain. Remember it's all
a balancing act between the insurance company's profits resulting from
investing in the equity index and its ability to pay those profits into
the equity indexed annuity.

**Interest Recognition Periods**

Let's continue to use the above example. You earned
12% for the year, so you would expect to see 12% of your funds value
credited to your account. However, your account may be credited only
once a year with all your earnings or it might be credited more frequentley.

Obviously those indexed annuities that credit interest
to your account several times a year are more advantageous because the
interest will compound more often.

So as an investor, you are looking for a high cap rate,
a high participation rate, and frequent interest crediting to your annuity.

Next we will talk about income tax effects on annuities.

Income Taxes
and Annuities >>

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Types of Annuities