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Home » Misc Annuity Articles » How is Index-Linked Interest Calculated?
How is Index-Linked Interest Calculated?

The idea behind any investment is to get good returns and with terms and conditions that suit the investor. Annuities are ideal for every investor because there are many different types of annuities with features that suit the needs and requirements of every investor. For those who wish to make low risk investments and yet gain from the performance of the stock market index, the equity-indexed annuity is a good option. This is a type of fixed annuity wherein a basic rate of interest is offered to the investor. In addition the investor gains from the index-linked interest, i.e. the interest that is linked to the performance of a specified stock index such as the Standard & Poor’s 500 Composite Stock Price Index or the S&P 500 as it is popularly referred to.

There are different ways to calculate the index-linked interest and it is crucial for investors to comprehend them in order to understand the amount of money credited to them. The amount of additional interest that you receive from an equity-indexed annuity depends on the annuity you choose. Thus your decision of buying one annuity over another would depend on many factors such as the calculation of interest-linked interest, reputation of the insurance company, etc.

Calculation of additional interest is effected by the indexing method and on the participation rate. The indexing method refers to the way the change in the specific stock exchange index is measured, while participation rate is used to measure any change in the index. Here are some common indexing methods that are used to calculate the index-linked interest:

  • High-Water Mark: The interest in this case is calculated at different points in the term. It is based on the difference between the highest value of the index and the index value at the start of the term. This is usually calculated at annual anniversaries of the date when the annuity was bought. Interest, if any, is added at the end of the term.
  • Annual Reset: In this case the additional interest of the equity-linked annuity is calculated by comparing the index value at the end of the term with the index value at the beginning. The interest is added to the investment each year.
  • The type of annuity.
  • Point-to-Point: When using this method the index-linked interest is calculated on the basis of the difference between the value of the index at the end of the term and that the start.

 

While selecting an equity-linked annuity there are other issues related to the index-linked interest that need to be considered. Some of these include the cap rate or the cap; some annuities cap the index-linked interest and thus there is a maximum rate of interest for that annuity. The floor on equity-linked interest is the minimum interest that will be earned on the annuity. Usually this is 0% so if the index falls you do not bear any losses. Some annuities take the average value of the index into account and not the actual value of specified points. There also annuities that charge an administrative fee and deduct a certain amount from the index-linked interest of an annuity. The percentage subtracted is also referred to as the ‘margin’. It is advised that an annuity broker be consulted before investing in an equity-indexed annuity. This will ensure that investors make a well-researched and informed decision that suits them.


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