Index Annuity Crediting Methods

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Index Annuity Crediting Methods Explained

An index annuity is a type of fixed annuity offering principal protection and the ability to earn interest based in part on the performance of an external market index. The amount of interest your annuity earns is determined by index annuity crediting methods and crediting components. In this guide I will go over the types of crediting methods and components and how each of them work.

The three types of index annuity crediting methods are:

  • Annual point to point
  • Monthly Sum 
  • Two year point to point
Each of these index annuity crediting methods also has one, or multiple, limiting components that determine how much interest is ultimately credited to your fixed index annuity.

 

Index Annuity Crediting Components 

Before we cover the available index annuity crediting methods we should explain the different types of crediting  components. Crediting components will affect how your indexed interest is calculated. These crediting components include:

  • Cap
  • Participation Rate
  • Spread

 

Cap

Some fixed index annuities set a maximum rate of interest (or cap) that the contract can earn in a specified period (usually a month or year). If the chosen index increase exceeds the cap, the cap is used to calculate your interest.

For example, if the annual cap in a hypothetical example were 3.00% and the value of the index rose by 4.80%, the cap amount of 3.00% would be credited to your contract. However. if the index change was 2%, your contract would be credited 2% since that is lower than our hypothetical cap.

Index PerformanceCapInterest Earned
8%5%5%
5%5%5%
-3%5%0%

Participation Rate

In some annuities, a participation rate determines what percentage of the index increase will be used to calculate your indexed interest.

For example, let’s suppose the index rose by 10%. If a hypothetical FIA had a 75% participation rate, the contract would receive 7.5% in indexed interest.

Index PerformancePAR RateInterest Earned
10%80%8%
5%80%4%
-5%80%0%

Spread

The indexed interest for some annuities is determined by subtracting a percentage from any gain (spread) the index achieves in a specified period.

For example, if the annuity has a 4% spread and the index increases 10%, the contract is credited 6% indexed interest.

Index PerformanceSpreadInterest Earned
10%2%8%
5%2%3%
-5%2%0%

Index Annuity Crediting Methods Explained

Annual Point to Point

This is the simplest of all index annuity crediting methods. Annual point to point uses the index value from only two points in time so this may be a good choice if you want to  minimize the effects of mid-year market volatility.

Annual point to point chart for index annuity crediting method
Annual point to point index annuity crediting method
  • The index value from the beginning of the crediting period is subtracted from the value of the index at the end of the crediting period. 
  • The percentage of change is calculated.
  • If the value at the end of the year is higher than the beginning of year crediting component is applied to determine your interest credited. 

As an example let’s assume an index change of 7% and apply the cap, spread or participation rate. For this example we will assume a 5% cap, 2% spread and a 75% participation rate.

5% Cap = 5% Interest credited (index change up to the cap)

2% Spread = 5% Interest credited (index change – spread)

75% Participation Rate = 5.25% Interest Credited (index change X spread)

2 Year Point to Point

Two year point to point uses the index value from two points in two contract years apart so this index annuity crediting method may be a good choice if you want to limit the effects of volatility between these two points. 

Index annuity crediting methods 2 year point to point chart

The index value from the beginning of the crediting period is subtracted from the value of the index at the end of your second crediting period (two years). The percentage of change is calculated. If the value at the end of the second year is higher than the beginning of period one a crediting component is applied to determine your interest credited. 

Monthly Sum

Monthly sum is the most volatility sensitive index annuity crediting method. It can provide the most interest in steady up-markets but it can be adversely affected by large monthly decreases. 

Monthly sum index annuity crediting method chart
Monthly sum index annuity crediting method
  • On your contract anniversary each month the index value is compared to the prior month’s value, and the percentage of change is calculated.
  • At the end of the year the monthly index increases and decreases are added up. The increases are subject to a cap; however, the decreases are not.
  • If the final sum is positive you’ll receive that amount as interest
  • If the final sum is negative you’ll receive zero percent interest for that contract year.

Index Annuity Crediting Methods in Summary

The index annuity crediting method you select can significantly impact how much interest you earn so you should consider your options carefully. The chart below shows each index annuity crediting method’s sensitivity to volatility and interest potential. 

Monthly sum is the most sensitive to volatility but also has the highest earning potential.

Index annuity crediting methods sensitivity to volatility and upside potential diagram.

Is an Index Annuity Right for you?

The answer is “Maybe”

It ultimately depends on your financial goals and needs. Before purchasing an index annuity you should consider the all of the pros and cons. FINRA’s article. “ The Complicated Risks and Rewards of Indexed Annuities” is a good read for anyone considering adding an index annuity to their retirement portfolio. 

Ibbotson whitepaper on fixed indexed annuities download

Download the complete 23 page Ibbotson Whitepaper on Fixed Index Annuities

Have a Specific Question?

Annuities are distributed by My Annuity Store, Inc. Guarantees are subject to the claims-paying ability of the insurer. My Annuity Store, Inc. does not advise clients on the purchase of non-fixed annuity products. The information presented here is not intended to be a recommendation to purchase a fixed annuity, fixed index annuity, variable annuity, registered index linked annuity (RILA), immediate annuity (SPIA), longevity annuity, or Qualified Longevity Annuity Contract (QLAC). 

The contract features described may not be current and may not apply in the state in which you reside. Insurance companies often issue contracts which are ‘state-specific’. Insurance companies also change their products and information often and without notice. Annuities are subject to the terms and conditions of the specific contract issued by the insurer, are not FDIC or NCUA insured, are not bank guaranteed, may lose value, and are not a deposit. Please call (855) 583-1104 if you have any questions or concerns. 

The information presented here is not a representation regarding the suitability of any concept or product(s) for an individual and it does not provide tax or legal advice. You should always consult your own financial planning, tax, and legal advisors to determine if a fixed annuity, fixed index annuity, annuity with long term care rider, immediate annuity, longevity annuity, or Qualified Longevity Annuity Contract are suitable in your financial situation.

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Kiara Caudill

Kiara Caudill

I spent the first 10 years of my career as a clinical mental health therapist and I saw firsthand that finances play a large role in one’s happiness. A good financial plan is not only important to your financial health it’s also important to your mental health. I approach financial planning from a behavioral finance perspective using a goals-based approach. Kiara holds a B.A. Degree in Psychology from Goshen College and an M.A. in Clinical Mental Health Counseling from Valparaiso University.

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Annuities are distributed by My Annuity Store, Inc. Guarantees are subject to the claims-paying ability of the insurer. My Annuity Store, Inc. does not advise clients on the purchase of non-fixed annuity products. The information presented here is not of tax or legal nature and is not intended to be a recommendation to purchase a fixed annuity, fixed index annuity, variable annuity contract, registered index-linked annuity (RILA), immediate annuity (SPIA), longevity annuity, or Qualified Longevity Annuity Contract (QLAC). 

The contract features described may not be current and may not apply in the state in which you reside. Annuities are issued by Insurance companies and contracts are ‘state-specific. Insurance companies also change their products and information often and without notice. Annuities are subject to the terms and conditions of the specific contract issued by the insurer, are not FDIC or NCUA insured, are not bank guaranteed, may lose value, and are not a deposit. Please call (855) 583-1104 if you have any questions or concerns. 

The information presented here is not a representation regarding the suitability of any concept or product(s) for an individual and it does not provide tax, accounting, or legal advice. It is important to read the prospectus carefully and consider your objectives, risks, fees, and charges associated with the contract. You should always consult your own financial planning, tax, and legal counsel to determine if a fixed annuity, immediate annuity, longevity annuity, or Qualified Longevity Annuity Contract are suitable in your financial situation.

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