Equity Indexed Annuity Benefits: Reality or Hype?

With the recent volatility in the stock market, insurance agents are coming to the rescue. The pitch – if you could invest your money so that it could achieve positive returns from the stock market and never suffer the losses, you’d think that was a pretty good proposition, wouldn’t you? That’s the proposition being touted by annuity salespeople with the equity indexed annuity (EIA), a complicated annuity product that offers investors “the best of both worlds.” While the basic premise of “all gain and no pain” appears to be true on the surface, a look under the hood of these products reveals some potential problems for investors who think they are buying added peace of mind.

EIAs are not easily explained, but the basic idea is that they are a fixed annuity with yields based on a percentage of the gain in a stock index, such as the S&P 500 to which they are linked. When the index achieves a gain, the annuity account is credited with a portion of the gain. And, if the index suffers a loss, the account is credited with a minimum return of 1 to 3 percent. So far, so good.

Setting aside, for the moment, that an EIA is designed to limit your upside gain with participation rates and cap rates, the real problem is in trying to figure out just what your percentage of the gain will actually be. The formulas used to calculate the credited amount are extremely arcane and they vary from one type of EIA to the next. Adding to their complexity is that fact that the annuity contracts allow for these formulas to change from year to the next.

But, even if you are willing to accept limits on your upside, there are also limits to their safety and downside protection which should raise some concern. Hefty surrender fees – as high as 15% charged on withdrawals that exceed 10% of your account value – can threaten your principal should you need to access your funds in the first 15 years of the contract. In fact, I once saw one of these contracts with a 22 year commitment! And, while life insurance companies are generally considered to be solid financial institutions, your only guarantee of principal safety is its backing by the life insurer. Although life insurers did escape the recent financial meltdown without harm to their contract holders, who would have wanted to be a customer of AIG waiting to see if the government would bail it out?

There are no absolutes when it comes to safety, but the closest are treasury securities and FDIC-backed accounts. And, given the complexity of EIAs, their hefty surrender charges and their high costs (how do you think they are able to pay the high commissions to their salespeople?), there are some fairly compelling reasons to avoid them, especially if you can achieve the same investment objectives with less complicated and less costly alternatives.

We always advise our clients to stick with investments that they can fully understand, and to stay focused on their specific objectives. Any investment that can’t be easily explained and that requires a long term contractual commitment is likely to become a distraction from the important issues.


This information is provided for general information purposes only and is not intended to provide specific investment advice. The information in the articles should not be relied on for tax reporting, accounting, or valuation purposes. Past performance is not a guarantee of future performance. It is not possible to invest directly in an index.

Please note that links to third party websites are provided as a courtesy. When you link to a third-party website, you are leaving this website. We make no representation as to the completeness or accuracy of information provided at these websites. Nor are we liable for any issues or consequences arising out of your access to or your use of third-party technologies or websites made available through this website.

2018-08-15T10:08:45+00:00

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