Understanding the Monthly Average Crediting Method in Fixed Index Annuities

The monthly average crediting method for a fixed index annuity calculates the average of 12 monthly index values over a contract year to determine how much interest you earn.

Throughout a contract year, an insurer tracks the index value at the end of each month. Then, they average those 12 values before subtracting the starting index value from the monthly average. That result is then divided by the starting index value.

If that final number is positive, the insurer may apply a spread or participation rate to determine the indexed interest you receive. A spread is the amount your insurance company takes from your gain before crediting interest to your account, and a participation rate is the percentage of the gain you’re allowed to keep. If the final amount is negative, you won’t receive any indexed interest, but you also won’t lose money.

If an index started the contract year at 1,000 and the average index value was 1,070, then the monthly average would be 7% (70/1,000 x 100). In this case, the index increased by 7%. If the spread was 5%, your indexed interest would be 2%. If your contract uses a participation rate such as 80% instead, your credited interest would be 7% × 80% = 5.6% interest.

Some insurance companies set rate caps that limit the maximum return you can receive in any given year. For example, in the above example, if your contract has a rate cap of 4%, your account will only be credited 4% even if the index increase is higher.

According to the National Association of Insurance Commissioners, insurance companies often use rate caps, especially if the participation rate is 100%. That said, most monthly average crediting methods use participation rates rather than caps.

Like any strategy, the monthly average crediting method has its strengths and limitations.

The monthly average crediting method isn’t the only fixed index annuity crediting method to choose from. Here are two other widely used crediting methods to consider:

The monthly average crediting method tends to make the most financial sense when you expect markets to be volatile. Because this method averages the monthly highs and lows over the course of the year, it smooths out volatility and offers more downside protection. If you’re a conservative annuity buyer who values consistent growth over high returns, the monthly average crediting method may be a safer option.

Beyond understanding how monthly average crediting methods work, you’ll also want to keep factors like participation rates and rate caps in mind. Participation rates determine the percentage of index gains credited to your annuity, and rate caps limit your maximum possible returns.

Insurance companies typically set cap rates based on factors like market conditions and their financial strength. During volatile markets, insurers might lower participation rates to mitigate risk.

When choosing a fixed index annuity, make sure you understand the contract terms, the specific index your annuity is tied to and the insurer’s overall reputation and financial strength. It’s also a good idea to review product illustrations and historical performance scenarios to get a clearer picture of how the annuity might perform over time and under different market conditions.

According to an AARP survey from January 2024, only around one-third of Americans have enough saved for retirement to live comfortably. If you’re nearing retirement, consider ​putting your money in fixed index annuities to grow your savings and create lifetime income with no downside risk.

That said, these products are not for everyone. Make sure you fully understand the pros and cons of annuities, as well as how different types of crediting methods work, before purchasing one.

If you aren’t sure whether the monthly average crediting method fits your long-term financial strategy, speak with a licensed annuity expert or financial advisor who can help you make the right call.

Editor Norah Layne contributed to this article.