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Equity Indexed Annuities
Equity indexed annuities are said to be one of the most popular insurance products today.
So, your profits are limited, but so is your risk of failure! This certainty on returns is the main selling point of an equity indexed annuity.
How Equity Indexed Annuities Began
Annuities have been viewed as prudent investments for as long as anyone can remember. An annuity is an excellent way to build your money, even as it allows you to defer paying taxes on your earnings.
An equity indexed annuity marries benefits from the two traditional types of annuity:
- Fixed annuity, characterized by:
- A fix, insurer-guaranteed return; and
- Modest returns in exchange of the guarantee.
- Variable annuity, which:
- Allows you to place funds in an investment-grade security of your choice; and
- Offer you higher gains, but higher risk as well.
The Risk of Equity Indexed Annuities
Although they do give you the best of both worlds–market-driven returns PLUS minimum guaranteed return–you can still lose money by purchasing an equity indexed annuity.
If you, for any reason, need to cancel your annuity earlier than the prescribed time you will lose money. In spite of a guarantee, you lose if your guarantee covers any amount that is lower than the total amount you paid for your annuity. More often than not, it will take you several years to break even on your equity indexed annuity.
Your loss can be compounded by a big surrender charge, PLUS federal tax penalties for canceling early. Some companies also withhold interest credits from annuities that are not held onto until maturity.
What Factors Impact Earnings?
They may be highly attractive, but equity indexed annuities are also complex products loaded with features that impact your gains.
When insurance companies credit their equity indexed annuity clients with LOWER RETURNS THAN ACTUAL INDEX GAINS, this simply means that several factors come into play, such as (using figures from the SEC website):
Participation rates – How much of the index increase is used to compute your index interest rate. If, for example:
Participation rate = 80%
Index gains = 9%
Then, your annuity return = 7.2% (9% x 80% = 7.2%)
Interest rate caps – Maximum rate of interest that you can earn. If, say:
Upper limit cap = 7%
Index gains = 7.2%
Then, your annuity return = 7%
Margin, spread, or administrative fee – Percentage subtracted from any index gain. For example:
Spread = 3%
Index gains = 9%
Then, your annuity return = 6% (9% - 3% = 6%)
The indexing method your insurance company uses to compute your equity indexed annuity gains can also substantially impact your earnings.
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