Indexed annuities provide potential investment returns with a guaranteed minimum rate, linked to market indexes such as S&P 500 with caps and floors to limit gains.
Growth and safety are two essential characteristics of investing, and equity-indexed annuities offer both. Unfortunately, however, they also present challenges such as annual “caps” on growth and greater complexity than some alternatives.
Equity-Indexed Annuities
One of the hottest annuity products available today is an equity-indexed annuity (EIA). EIAs can offer investors the best of both worlds by combining fixed annuities (which limit losses to principal) with some of the upside potential of stocks (within certain limits).
Indexed annuities apply interest to your contract using a formula tied to changes in market indices like the S&P 500. In most contracts, there will also be a minimum guaranteed rate, meaning even when index values fall below certain amounts, your annuity won’t lose money.
However, annuities should not be considered pure investments; there are reasons that make these annuities riskier than other annuities. For instance, these annuities don’t usually include reinvested dividends in the calculation of index gains (which have historically made up an important component of market returns), and are frequently sold through insurance agents rather than being subject to securities regulations.
Equity-Indexed Life Insurance
An equity-indexed life insurance policy is a form of permanent (cash value) life insurance which combines life coverage with investments. A portion of every monthly premium pays for life insurance benefits while another amount accumulates as cash value that can then be invested into stock-influenced assets.
Index-related investment accounts receive interest annually based on the difference between their starting index value and ending index value for each index term, which usually lasts one year. A comparison is then made of how much your index gained during that term versus when it started, with any percentage gains calculated and interest awarded accordingly; subject to cap and participation rate caps and participation rates as applicable.
EIULs provide key advantages such as tax-free death benefits and cash accumulation; however, similar to variable annuities they carry the risk of losing money during negative stock market returns without a minimum guaranteed interest rate in place. It is wise to consult a financial advisor before selecting this investment option.
Equity-Indexed Fixed Annuities
An equity-indexed annuity combines market potential with protection against losses. These annuities typically credit interest based on how well a specific index performs each year, usually with limits placed on how much growth can be credited annually.
An indexed annuity provides protection from downside risk by offering a minimum guaranteed return of 1-3% on 90% of premiums invested, without taking reinvested dividends into account when calculating returns attributed to it.
These annuities can be complex to understand and come with high fees, such as those charged for contract changes or early withdrawals, which may incur IRS tax penalties before age 59 1/2. Therefore, they’re best utilized as part of a broader retirement savings plan rather than acting as the primary source of retirement income; an experienced advisor can help determine if such an annuity fits with your needs.
Equity-Indexed Variable Annuities
Equity-indexed annuities combine a guaranteed minimum interest rate with returns based on changes to a specified market index, providing protection from market losses while potentially outstripping inflation with gains that outpace it. While such products could fit nicely into some retirement portfolios, it is crucial that investors fully comprehend all their complexities prior to investing.
An annuity may be suitable for investors looking for market upside without taking on risk from market downswings, with at least some guarantee of at least minimum return and typically setting participation rates which determine how much an index increase gets credited back to their annuity.
Like all annuities, single premium annuities do not fall under federal Securities and Exchange Commission regulation and can typically be sold by financial professionals without needing a broker’s license. Gains accruing until withdrawal can often be taxed as income rather than deferred until withdrawal occurs – making them an attractive alternative to bonds or CDs for many investors.
