What is an Equity Indexed Annuity?
There is type of annuity that falls somewhere in between these two known as an equity indexed annuity. This is a type of annuity that proves to be alluring to some investors because it is pitched as a way to see profits on their annuity, without actually exposing their principal to risk.
Essentially, the investor receives part of the interest they would have received for a normal fixed annuity; however, the rest of the interest becomes linked to an equities index like the S&P 500. The investor can see returns based on how the index performs over the life of their annuity.
Equity Indexed Annuities
Annuities are investment vehicles designed for an individual’s retirement. Essentially, an investor pays scheduled premiums up until their retirement date—at which point they begin receiving scheduled distributions that act as their income during retirement.
A fixed annuity is pretty straight forward. The amount that the individual receives during retirement is dependent on the premiums they paid into the annuity—plus interest.
A variable annuity, on the other hand, operates differently. The premiums that an investor pays into the annuity are invested in the equities market. The amount that the individual receives during their retirement is dependent on how well the invested funds performed in the market.
The Down-Side of Equity Indexed Annuities
What investors are not told is how truly illiquid these products are—even more so than regular fixed and variable annuities. Cancellation fees for these annuities can range up to 20%, and the length of the surrender period is longer than with a regular variable or fixed annuity. Because of this, these products should never be recommended to investors with higher liquidity needs.
Many securities brokers ignore their duty of acting in the client’s best interest and recommend equity indexed annuities because of the incredibly high commissions they receive when selling this product. Brokers can receive commissions as high as 10% of the premiums paid when an individual purchases an equity indexed annuity.
Most fixed annuity interest rates are just over 1-2% percent and the complex crediting formula leads to only small returns in a healthy equity market. This makes it almost impossible for the investor to actually see a profit under anything other than an exceptional performance by the index over the life of the annuity.
Securities brokers utilize the complex nature of equity-indexed annuities to push them onto unsuspecting investors. The truth is that these products are not suitable for any investor. Individuals would be far better off saving for retirement in other ways. If they are dead set on annuities, then fixed annuities are at least safer in regard to the fees and commissions charged to the investor.
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