An Equity-Indexed Annuity (“EIA”) is a financial product from insurance agencies that offers a minimum guaranteed return combined with a return linked to a market index. EIAs involve an “accumulation period,” when an investor makes a lump sum payment or a series of payments to the insurer, and a period following the accumulation period when the insurer makes a lump sum payment or a series of payments to the investor.
EIAs have many potential disadvantages, including surrender charges and tax penalties that are incurred if the investor cashes 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. Different EIAs use different methods to calculate gains in the index, with each method having distinct advantages and disadvantages. EIAs are complex instruments and they can be very difficult to understand. Elements of EIAs that investors should pay attention to include participation rates, interest rate caps, and the 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 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.
Investors should also investigate the financial strength of the insurance company offering the EIA to make sure that they will be able to make their payments.
EIAs are not necessarily fraudulent, but they are not right for all investors. Investors considering an EIA should be prepared to assess the instrument in detail, conduct research, and ask questions.
For more information, see:
- Financial Industry Regulatory Authority (FINRA): http://www.finra.org/Investors/ProtectYourself/InvestorAlerts/AnnuitiesAndInsurance/P010614