Unlike set-rate contracts, a fixed index annuity uses market index performance as a measuring tool. Then, it applies a formula called a crediting method to calculate the interest that goes into your contract. The result depends on 2 key factors: when the index is measured and how the contract limits your gains.
This guide explains the most common index annuity crediting methods and shows how those limits work in practice. If you’d rather know your rate from the start, we’ll also see how a fixed rate, multi-year guaranteed annuity (MYGA) like Gainbridge SaveSM Annuity offers a more straightforward interest crediting structure.
What are index annuity crediting methods?
An index annuity crediting method is the contract rule used to calculate interest based on changes in a market index. Common methods include point-to-point, performance-triggered, and monthly sum. Each one measures index movement, then applies contract terms such as caps or participation rates to determine the final interest credit.
Your money isn’t invested directly in the index, and the contract doesn’t credit the index’s full return. If the index falls during the measurement period, the credit is generally 0% rather than negative, subject to contract terms. A 0% credit still means no growth for that period, and fees or withdrawals can reduce contract value.
Keep in mind that annuities are long-term insurance contracts, not bank deposits, and they do have potential downsides. They aren’t insured by the FDIC or NCUA, and any guarantees are backed solely by the claims-paying ability of the issuing insurance company.
The rate levers: Cap, participation rate, and spread
A contract’s crediting method determines when the index is measured. After that, the cap, participation rate, or spread affects how much of a positive index change becomes credited interest.
Here’s how each of those levers works, with a few hypothetical examples:
- A cap rate sets the highest interest credit available for a specific measurement period. With an 8% cap, a 12% index gain would result in an 8% credit.
- A participation rate sets the share of the index gain used to calculate interest. At a 60% participation rate, a 10% index gain would result in a 6% credit.
- An annuity spread or margin is subtracted from the index gain before interest is credited. With a 2% spread, a 10% index gain would result in an 8% credit.
A contract may use one of these levers or combine them. The rates can also reset for a new term, so the same index gain may not produce a steady credit every time.
How point-to-point crediting works
The most common index annuity method is point-to-point crediting. This method compares the index value on 2 dates, then applies the contract’s cap, participation rate, or spread to calculate interest credit. If the index ends lower than when it started, the credit is generally 0%, and the contract’s principal doesn’t decline.
Most point-to-point index annuities are annual, measuring value across a single year. But others use a 2-year period instead, where you receive one credit at the end of that time. For these contracts, a strong second year can offset a weak first one, but a poor second year can also reduce your gains from the first. Some contracts offer higher caps or participation rates to compensate for the added delay and risk.
Other index annuity crediting methods you’ll see
Some contracts are more complex, tracking changes throughout the year or using a preset credit when the index meets a certain condition. Those contracts may use methods like:
- Monthly point-to-point: Also called monthly sum, this index annuity crediting method adds together each month’s index change throughout the year. Monthly gains are usually limited by a cap, while monthly declines are typically counted in full and uncapped. In a year with frequent ups and downs, those uncapped losses can reduce or erase gains from stronger months.
- Monthly averaging: This method uses several index values from across the year, rather than comparing only the first and last day. The contract averages those values to calculate the index change, which can reduce the effect of a sharp rise or drop near the end of the period.
- Performance-triggered: This type of index annuity credits a preset rate when the index finishes flat or higher. If the index ends lower, the credit is generally 0%, no matter how large the decline was. The size of a positive index gain doesn’t change the preset rate.
Which crediting method works best for you?
Annual point-to-point offers the most straightforward calculation, while monthly averaging can soften the effect of a late decline. Monthly sum depends more heavily on the path the index takes throughout the year.
To choose the best option, consider the method’s strengths and weaknesses alongside the contract’s cap, participation rate, or spread. From there, determine how the index annuity’s level of variability fits in with the rest of your retirement plan, including any low-risk investment options you already use.
Let’s sum up the basics of each method.
- What shapes the result: The difference between the index value at the start and end of 1 year
- Calculation complexity: Lower
- What shapes the result: The index change across 2 years, with a single credit calculated at the end
- Calculation complexity: Lower
- What shapes the result: The total of all monthly changes, with gains typically capped and losses counted in full
- Calculation complexity: Higher
- What shapes the result: The average of several index values recorded during the year
- Calculation complexity: Moderate
- What shapes the result: Whether the index finishes flat or higher, rather than the size of the gain
- Calculation complexity: Lower
Why crediting method can matter more than cap rate
Cap rate tends to stand out because it shows the most interest a contract can credit. But the crediting method is what determines how index change is measured, and whether interest calculations actually reach the cap.
Consider a hypothetical contract that uses the monthly sum method, with a 3% cap. During each positive month, gains would be limited to 3%, while negative months could count in full. In a choppy year (i.e., a year with frequent market ups and downs), the final credit may be small or even 0%. In comparison, an annual point-to-point method with a 7% cap would credit up to 7% if the index finishes the year at or above that gain. Caps, participation rates and spreads shown here are hypothetical and are not the terms of any particular contract; actual terms may reset each period.
That’s why it’s important to compare the full calculation for each contract you look at, not the cap alone. Look at the method alongside its cap, participation rate, or spread, and consider how that combination could behave under different market conditions.
Skip the complexity and get a fixed rate instead
With index annuities, the final interest credit depends on both index performance and the contract’s calculation rules. That means your results can vary from one crediting period to the next, even when those periods use the same index.
Flex℠ is a fixed rate MYGA that does not use index tracking, crediting methods or rate levers, and therefore has no potential for index-linked upside. Instead, your contract earns a fixed rate for the term, which makes the interest credited over the term easier to understand.
With Flex℠, you can buy an annuity online without working through a broker. Contract value is not linked to market performance. Withdrawals above the free withdrawal allowance are subject to surrender charges and any market value adjustment, which can reduce the amount you receive below premium paid.
Choose the crediting structure that fits your goals
Choosing between an indexed and a fixed annuity involves a tradeoff: a fixed rate is certain but capped at the declared rate, while an indexed contract offers index-linked crediting that may exceed or fall short of a fixed rate. An indexed annuity uses a formula tied to market movement, while a fixed annuity offers a set rate for a specific term.
To see how these options might fit into your investment goals, check out our article on the best annuity for retirement. Then compare the current Save℠ fixed rate. No sales commissions and no annual contract fee are charged; surrender charges and any market value adjustment apply as described in the contract.
This article is for informational purposes only. It is not intended to provide, and should not be interpreted as, individualized investment, legal, or tax advice. The Gainbridge Flex® digital platform provides informational and educational resources intended only for self-directed purposes.
FAQ
How is interest calculated on an indexed annuity?
A fixed index annuity uses a crediting method to measure changes in an index over a set period. The contract then applies a cap, participation rate, spread, or combination of those terms to calculate the interest credit.
What’s a good cap rate on an index annuity?
No single cap rate is best in every case and market. A higher cap can allow for higher interest, but the crediting method and other contract terms will affect how much of the index gain you actually earn.
Do you lose money in an index annuity if the market drops?
A negative index result generally produces a 0% interest credit rather than a market-based loss of contract value. However, a 0% credit means no growth for that period, and withdrawals, surrender charges and any market value adjustment can reduce what you receive below premium paid.
What’s the difference between a cap and a participation rate?
A cap sets the highest interest credit available for a period, while a participation rate sets the percentage of the index gain used in the calculation. So, for example, a 60% participation rate would use 60% of the gain before any other contract limits apply.
Is a fixed annuity simpler than an index annuity?
A fixed annuity is generally easier to understand, because it uses a set rate for a stated term instead of an index crediting formula. SaveSM is a fixed rate MYGA, not an index annuity, and it doesn’t use caps, participation rates, or index tracking.
