Equity Indexed Annuities

EQUITY INDEXED ANNUITIES ,

Equity Indexed Annuities can often be an excellent solution for anyone with long term money to invest, but with a strong need to avoid risk. An Equity Indexed Annuity can help an investor avoid two major risks – The risks of low returns, and the risks of capital loss. Take, for example, the case of Jack and Cindy. Jack is a sixty five year old retiree with $200,000 in retirement funds targeted for long term savings and growth. Jack and Cindy also have a small employer pensions and social security providing for living expense cash flow. Jack and Cindy are likely looking forward to 20 to 40 years of retirement and need to grow their nest egg so that it lasts for decades. It has taken Jack his whole working life to accumulate these funds, and he has no way to replace them if he loses money on a risky investment. On the other hand, if they invest too conservatively and only secure a minimal fixed return, their nest egg won’t grow enough to take care of them in their later years.

An Equity Indexed Annuity (EIA) could be an excellent fit for a family like Jack and Cindy. An Equity Indexed Annuity is an insurance product that credits the owner with income based on the growth of a related stock market index. It is not a mutual fund, and is not considered a “security” because there is no risk of loss to your invested principal. The insurance company promises to absorb any losses in your investment in exchange for keeping some of your investment growth in positive years.

A simple EIA might work like this. Jack and Cindy could purchase an EIA with a Point to Point Crediting method, tied to the S&P 500, with an annual reset, a 7.5% cap, 100% participation rate, no spread, no costs, no fees.

First lets define the terms: Point to Point crediting means that the policy has specific dates where the value of the associated index is verified, and used to credit your account with whatever gains the market index made in that period. There are EIA products that check the market and lock in your gains each month, indexes that check each year, and even products that check once every other year. In Jack and Cindy’s case they chose a policy that checks the market and locks in gains once per year based on the performance of the S&P 500 index.

In our example, Jack and Cindy chose a simple Cap Rate product with no margin and 100% participation. That means that whatever growth the market index shows is directly credited to their account without deduction – up to the first 7.5% in market growth. If the market goes up 3% they get all 3% with no costs or fees. If the market goes up 10%, they go up 7.5%, again with no costs or fees. And if the market drops 20% the carrier absorbs the loss. Even better, that new lower market value becomes Jack and Cindy’s new baseline, and if the market recovers 10% the next year Jack and Cindy would go up an additional 7.5% even though the market hadn’t yet recovered to their original buy-in price. That means that if the market went down 20% and recovered 7% per year for 3 years a mutual fund investor would still be just around breakeven and Jack and Cindy would be up over 20% for the three years. With a simple cap rate product, Jack and Cindy have traded away the highest end of their potential upside (above 7.5% per year) but in exchange, they’ve gained themselves bullet proof insulation against a market contraction.

So, in more general terms, funds that are performance-linked to the S&P 500 stock index, such as equity indexed annuities, are appealing to many people who want to earn competitive rates of return on their investment without market risk.

The first and possibly most-attractive provision of equity index annuities is the no-loss provision, or minimum rate guarantee. This means that once a premium payment has been made or interest has been credited to the account, the account value will never decrease below that amount. This provides safety against the volatility of the market index like the S&P 500.

The next benefit that appeals to many people is interest guarantees. Most policies have a cap (the maximum interest rate that can be credited to a policy in a policy year) and a floor (the minimum interest rate that can be credited in a policy year). The cap rate can vary from no cap to a fixed percentage, but the floor is generally zero. This allows the policyholder to benefit from potentially high returns and be guaranteed at the same time that no money will be lost.

Finally, equity index annuities offer the same benefits as traditional annuities, such as tax-deferred growth and early withdrawal of funds without penalty. This early withdrawal is usually conditioned upon the annuitant’s death or admittance to a nursing home. Guarantees are provided by the issuing insurance company.