Understanding monthly point to point annuity with cap accounts is very important if you are a current or potential indexed annuity investor. Typically, these accounts offer some of the highest potential for yearly returns when markets steadily trend upward.
This post is the second in our ongoing series discussing indexed annuity sub-accounts. Our first was an explanation of the yearly point to point (PtP) account. The monthly version works a bit differently, but in the right market environment, it can credit significant returns.
Hopefully, you are well read on the pros and cons of indexed annuity investing. We are taking it a step further here and describing how a point to point sub-account credits interest to indexed annuities. (See Chart Below)
Almost all indexed accounts offer the PtP option. And some offer it for different market indexes like the S&P 500, NASDAQ or Dow Jones – all within the same annuity. The PtP option (like most investments) performs best when the market is climbing steadily with few significant declines.
It’s important to note that not all PtP accounts work in the same manner, but for the purposes of this article, we will explain the most common type and its yearly interest crediting method.
First, you must understand that the PtP is almost always a yearly account. No interest is credited until your 12 month term has been reached. Oftentimes, consumers see the word monthly and think the account will credit interest each month. This is not the case.
The monthly point to point annuity account credits interest yearly based on the performance of the chosen index – usually the S&P 500. The yearly interest credit is calculated by adding the monthly gains (subject to cap) and subtracting the monthly losses (no cap) each month – usually over a twelve month time period. This twelve month time period will not necessarily track the calendar year.
Not all annuity sub-accounts have a monthly cap, but the point to point account almost always does. If the monthly gains in the S&P 500 are the gas that power your returns, then the monthly cap is the brake. An annuity cap is a very important number and investors need to work with an agency like ours to find the best one.
It’s as simple as this: The lower the cap, the lower your potential for gains. The cap is not your friend; it’s the mechanism insurance companies use to hedge against losses and remain profitable so that your money stays safe & insured.
The easiest way to explain how interest is calculated and credited to your annuity is by a hypothetical example. Most of 2013 was a very good year for investing in the overall markets. The market went up most months, there was little volatility, and the bad months weren’t too bad in comparison to some years in the past.
|Month||S&P 500 Return||Annuity Cap||Cap Applies?||Annuity Gains|
So what do the numbers in the chart above mean? In a nutshell, the S&P 500 gained 26.55% (excluding dividends) in 2013 – and an indexed monthly point to point annuity with a 2.50% cap would have returned 17.73% during that same time period. Are these gains realistic? In a word yes, but of course 2013 was a good year in the market and was not the norm over the last decade.
As with all insured indexed annuities, you are sacrificing some gains for safety, stability and peace of mind. You would not expect returns of 17% on a regular basis, but it is comforting to know they are possible and that you will never experience market losses of any kind – ever.
Yes, you can never go below zero – no matter how far the market tumbles. One bad month can erase all of your monthly gains for your 12 month term, but your account will not decrease in value overall and your gains from prior years are locked in.
In other words, you can have a year with no gains when investing in a monthly point to point annuity, but not a year where your account loses money. Your premium bonus and gains from prior years are locked in and not subject to market downturns.
You can see in the chart above that there are no downside caps for months where the S&P 500 turned negative. The worst case scenario is that you could be having a good year, but a big market correction could wipe out all of your paper gains from the first 11 months. In this instance, your annuity would not credit interest, but even if the market was down overall, your annuity would not lose value.
Hyers and Associates Inc. is a full service insurance agency specializing in indexed annuity accounts. We can help you compare the caps, bonuses, terms and all other details of the indexed annuities that are most likely to offer the best performance.