Annual Crediting Cap

The little-known brother to the Hogwarts sorting hat, worn by each student at the end of the year to determine their grades. Alas, we’re just kidding. This actually involves annuities.

An annuity is an investment that pays a certain amount each year over a period of time. They come in a lot of varieties, each with its own provisions. One form of annuity is the indexed annuity, which ties returns for its principal to a certain stock index...the S&P 500 or the Dow Industrial Average, for example.

To protect the investment, the annuity might guarantee a certain minimum growth rate, which comes regardless of what the index does. However, to allow the company to earn some profits somewhere, the annuity might also have a have a maximum growth rate. This is the annual crediting cap.

The benefit of these annuities to the customer is that they are safe...there is at least a minimum guaranteed growth rate. But the customer buys that safety by giving up the chance for big growth in years when the stock market performs extraordinarily well. The downside and upside are both capped.