# How Does The Interest Calculation In Fixed Index Annuities Work

Fixed Index Annuities pay interest based on a formula calculation that is tied to a stock index such as the S&P 500. In addition to a market index, the formula calculation also uses a number of components to determine how much interest you will be paid, and when that interest will be paid.

### What Are The Typical Fixed Index Annuity Calculation Formula Components

There are two main components that influence the interest calculation formula in a Fixed Index Annuity.  They are the Indexing Method and the Participation Rate.

Indexing Method

The indexing method is used to measure the amount the index has changed. The most common indexing methods include an annual reset, a high-water mark, and a point-to-point method.

Annual Reset: The Fixed Index Annuity interest rate is calculated by comparing the index value at the end of the contract year, with the index value at the start of the contract year.

Point-to-Point: The Fixed Index Annuity interest rate is based on the difference between the index value at the end of a defined period of time, and the index value at the start of that period of time.  The Point-to-Point can be monthly or annual.

High-Water Mark: The Fixed Index Annuity interest rate is determined by measuring the index value at various points during a defined period of time.  Often, the annual anniversary of the date you purchased the annuity is used as a measuring point. The interest payment is based on the difference between the highest value of the index during the period, and the value of the index at the start of the period.

Participation Rate

The participation rate is used to determine how much of the index increase will be used to calculate your interest.  Your participation rate will be set by the insurance company upon funding the annuity, and will usually be guaranteed for a specific term.  Once that term is over, the insurance company will set a new participation rate.  Often, your Fixed Index Annuity will provide a guarantee that your participation rate will never be set below a certain rate, or above a certain rate.  An example of a participation rate is as follows.  If your participation rate is set at 75% of the S&P 500, and the S&P 500 gains 11%, your interest rate will be set at (11% X 75% = 6%).  Your annuity will earn 6% interest for that term.

In addition to the Indexing Method and Participation Rate, the other components that will effect your Fixed Index Annuity Interest Rate are:

Cap Rate or Cap
A Fixed Index Annuity may define an upper limit, or cap, on the index-tied interest rate calculation. The Cap Rate defines the maximum rate of interest the Fixed Index Annuity will earn.  Some, but not all, Fixed index Annuities have a Cap Rate.

Minimum Interest Rate or Floor
The minimum interest rate defines the minimum interest you will earn for the term. It is common for a Fixed Index Annuity to define the interest floor as 0%. With a 0% floor you may not earn interest in a bad stock market period, but you will not ever suffer a decrease in annuity value.

Averaging
A Fixed Index Annuity may use an average of an index’s value rather than the actual value of the index on a specified date. The index average may be taken at the beginning, the end, or throughout the entire term of the annuity.