A fixed index annuity (FIA) or equity indexed annuity is an insurance contract that combines a principal security with potential market-linked returns. If the chosen market index linked to the annuity performs well during the year, the annuity holder receives a portion of those gains in the form of interest. The annual reset is the mechanism by which those gains are “locked” into the accumulated value of the annuity, ensuring that the interest is protected from potential market downturns in the future. A financial advisor can help you determine whether an FIA or other annuity is a good fit for your retirement planning.
What is Annual reset?
At its core, the purpose of an annual reset is to provide investors with an opportunity to benefit from market growth while protecting their principal against market downturns. The performance of FIAs is typically correlated to a chosen market index, such as the S&P 500. However, unlike direct investment in the stock market, annuities do not involve buying stocks. Instead, it offers the potential for interest credits that are based on the performance of the index.
Every year, on the anniversary of the annuity contract, the insurance company checks the value of the index. The accumulated interest of the annuity is determined by measuring the performance of the index from the beginning to the end of the contract year.
If the index shows growth, a portion of that growth—subject to certain limits known as the “cap” or “participation rate”—is added to the value of the annuity. Importantly, even if the index experiences a decline during the year, the principal of the annuity is protected from those losses.
How Annual Reset Works in a Fixed Index Annuity
At the end of the tracking period, the value of the annuity is reset based on the positive performance of the chosen index. This means that the gains made during the year are locked in and the new value becomes the starting point for the next tracking period.
Over time, the value of the annuity is likely to increase as gains from previous years are added to the accumulated value. This compounding effect can lead to significant increases in the value of an annuity, especially during periods of continued market growth.
But even if the market index experiences losses in subsequent years, the value of the annuity remains unaffected by these downturns. The process of annual resetting and compounding is repeated every year, allowing your annuity to enjoy market gains while being protected from losses. This cycle continues until you decide to start receiving income from the annuity.
Annual reset example
An investor has a fixed index annuity with an annual reset and a present value of $10,000. The specified market index posted a 7% return at the end of the contract year. As a result, the value of the annuity would increase by 7% to $10,700.
However, if the annuity contract includes a participation rate, only a portion of the 7% profit will be credited to the accumulation value. If the annuity in the above example had a 90% participation rate, the accumulated value would have increased by 6.3%.
Pros and Cons of Annual Reset
The annual reset feature brings both advantages and potential disadvantages for investors.
The annual reset feature of a fixed index annuity offers an interesting balance between market-linked growth and principal safety. While it offers the potential for higher returns, it is important for individuals to consider their risk tolerance, financial goals and the terms of the annuity before making a decision.
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