What Is the Annual Reset Method?
The annual reset method is one indexing method that insurers use to calculate the interest for a fixed index annuity. Indexing methods measure the performance of an annuity’s underlying index and translate any growth in index value to gains in the annuity’s value.
“An annual reset simply means that you look at the index value at the end of the year in comparison to the beginning of the year,” Matt Lewis, a certified long-term care (CLTC) specialist and vice president of Insurance at Carson Group, told Annuity.org. “If the index is higher at the end, the account value is reset to the higher point.”
Each year, the index’s value becomes the new starting point for next year’s calculation, hence the name annual reset. This sets annual reset contracts apart from other designs, which typically only use the index’s value on the first day of the contract as a starting point.
Key Facts About the Annual Reset Indexing Method
- The annual reset method is a fixed index annuity contract design that measures the underlying index’s performance annually.
- An annual reset contract credits interest each year the index shows a gain, allowing the annuity to compound its growth.
- Although the annual reset method can have higher potential returns than other contract designs, it is complex and can come with limiting provisions.
The annual reset method also differs from other contract designs because it credits interest every year there is a gain, rather than only once at the end of the annuity’s term. As a result, the interest on annual reset annuities can have the chance to compound, especially if gains occur in the early years of the contract.
Annuities with the annual reset method offer contract holders the opportunity to earn positive returns even in underperforming years.
Marguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®CEO of Blue Ocean Global WealthMarguerita M. Cheng, CFP®, CRPC®, CSRIC®, RICP®, is the chief executive officer at Blue Ocean Global Wealth. As a CFP Board of Standards Ambassador, Marguerita educates the public, policymakers and media about the benefits of competent and ethical financial planning. She is a past spokesperson for the AARP Financial Freedom campaign.
Annual Reset Method Example
The annual reset feature, also called an index reset, ensures that each year, your index value starts fresh based on the previous year’s closing value.
For example:
- You purchase an annuity when the index is at 1,000.
- After one year, the index falls to 900 → Your credited interest: 0%.
- Your new starting point is now 900.
- The following year, the index rises to 950 → Your credited interest: 5.55%.
Why This Matters
You don’t need to regain your initial purchase index value (1,000) to start earning interest again. This can be particularly beneficial after a market downturn, helping you recover faster in a rising market.
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Pros and Cons of the Annual Reset Method
The annual reset method might seem like the best contract design for a fixed index annuity, but each indexing method has benefits and drawbacks.
Pros
- Index gains can be locked in each year
- Interest compounds each year the index grows
- Returns could be available as early as the end of year one
Cons
- May have limiting provisions like low participation rate, rate cap or averaging
- Calculating returns is more complex than other contract designs
The strengths of the annual reset design include the ability to benefit from down years and the compounding effect of crediting interest to the contract every year that the index shows a gain.
Because the annuity can begin accumulating growth after the first year, an annual reset contract might be particularly advantageous for contract owners who want to make withdrawals before the contract’s term elapses.
However, every contract design has disadvantages as well. The annual reset design presents the most risk to the insurer, so most insurers use limiting provisions so that owners don’t receive the entirety of the index’s gains.
Additionally, the annual reset is perhaps the most complex contract design, and some customers may find it difficult to understand the details of the contract. Working with a financial advisor can ensure that you understand the index crediting method when you purchase an annuity with an annual reset design.
Editor Sierra Campbell contributed to this article.
