EIAs are financial products from insurance agencies that offer a minimum guaranteed interest rate combined with an interest rate linked to a market index such as the S&P 500. The investment is divided into two parts. During the accumulation period, the investor makes a lump sum or a series of payments. After the accumulation period, the insurer will make periodic payments back to the investor or can pay back a single lump sum amount.
Disadvantages of this type of investment is that there are typically surrender charges and tax penalties involved in cashing out an EIA early. Further, the minimum return guarantee may not even kick in until the account has been active for a set period of time.
EIAs, which are contracts between insurers and investors, can vary greatly. Three elements of these contracts are participation rates, interest rate caps, and the margin/spread/administrative fee.
The participation rate defines the impact of an index gain on the value of the annuity. The higher the participation rate, the greater the impact of an index gain on the value of the annuity.
Interest Rate Caps specify a ceiling for the impact of a market index. For example, if the linked market index increases by 10% and an EIA has an interest rate cap of 8%, the investor only benefits up to the cap (8%). The margin, spread, or administrative fee is another EIA provision that can affect the benefits an investor receives by reducing the return from a gain in the linked index by some percentage. For example, a policy might provide that investors only receive the benefit of two-thirds of any gain in the linked market index and so for a nine percent gain in the index, the return credited to the annuity is only six percent.
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