Annuities tied to a market index offer the investor the opportunity for a greater return on their investment than fixed annuities paying a guaranteed interest rate. However, because of their relationship to the index, they do contain a higher element of risk. In addition, the various methods of calculating the return can significantly alter the end result.

There are several variables involved in the calculation of the total return and consideration has to be given to each factor. These variables can be either fixed for the life of the annuity, or adjustable by the insurance company at specified dates.

1) Participation rate. The participation rate is a measurement of how much of an index's gain will be credited towards your annuity contract. For example, a participation rate of 90% on an index gain of 10% will result in a 9% gain credited to your account.

2)Asset Fees. An asset fee is a charge made against the index return. It may be in place of, or in addition too, the participation rate. If an asset fee is set at 3% for example, and the index has a gain of 8%, the total return will be 5%.

3)Caps. Some annuities place caps on your return regardless of the index's performance. Any excess over the cap is lost to the annuity holder in this case.

The exact method of calculating the index's return over a certain time period also affects the return paid on an Equity Indexed Annuity. Here's a brief overview:

The Point-to-Point method compares the change in the index between two distinct points in time. The return can be affected by short-term fluctuations in the index to a much larger degree with this method, should they happen to fall on a calculation date.

The High Water Mark method offers somewhat more protection. In this method, the value of the index is recorded at several dates in the term. The highest value is used in comparison with the beginning value to calculate the return.

An Annual Reset compares the value of an index at the beginning and end of the year. Gains are then locked in for that term. Since most contracts have a guaranteed rate of return, any drop in the index results in the minimum guaranteed return.

Averaging simply takes the index value on a daily or monthly basis and creates an average value over a certain term. This has the effect of smoothing out the return and offers some protection against volatility.

Selecting the right crediting method can be tricky, but we can help. We'll educate you on the pros and cons of each approach and help you make the right decision based on your needs.

Liquidated earnings are subject to ordinary income tax, may be subject to surrender charges and, if taken prior to age 59 1⁄2, may be subject to a 10% federal income tax penalty.

Guarantees and payment of lifetime income are contingent on the claims paying ability of the issuing insurance company.

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