Finding an annuity that meets all your financial goals can be difficult in today’s cluttered market, particularly those offering equity-indexed options.
An annuity often contains a participation rate, which limits how much of the market index’s gains are actually credited back into your account. Some also exclude dividends when computing index-linked gains.
1. High surrender charges
Index annuities are fixed deferred annuities with potential gains higher than what can be obtained with certificates of deposit (CD), money market accounts or bonds; additionally they offer protection from loss of principal.
Some index annuities provide their investors with a percentage of the growth in an index; the credit may be distributed either using an average or point-to-point methodology.
Insurance companies typically keep any excess if an index performs beyond its cap; other features of index annuity products may include guaranteed participation rates and volatility control indexes that should be carefully considered by any investor considering investing in them. Index annuities should not form the entirety of any retirement portfolio; however, selecting an annuity from a reputable provider can serve as an integral component for investors with suitable investment time horizons and risk tolerance profiles.
2. High commissions
Many indexed annuities come with steep sales commissions. Sales agents convince investors they can participate in the stock market’s upside while protecting themselves from its downside with these annuities, yet in practice their actual returns tend to be restricted due to caps on gains or other restrictions within an annuity contract.
Keep in mind that companies can alter the actual index return credited to annuity owners every year, which should serve as a warning sign and prompt you to read carefully the fine print. Shop around for better index annuity offers or consider making a 1035 tax-free transfer with another company to get more value out of an annuity or alternative markets for less cost.
3. Limited investment options
Equity-indexed annuities (EIAs) provide growth linked to a stock market index while offering principal protection and lifetime income stream benefits. Gains may be restricted through participation rates and/or buffers (sometimes known as floors), which establish maximum loss percentage allowed before insurance company reduces contract value.
An EIA’s interest rate is calculated with a formula tied to an index such as the S&P 500. Most insurance companies guarantee a minimum interest rate that they’ll credit to your account, meaning its balance won’t decrease below this amount even during negative market years. Furthermore, most indexed annuities contain caps on how much index-linked interest can accrue each year.
4. Limited flexibility
An indexed annuity is a type of fixed annuity that offers growth potential based on fluctuations in an index. These products tend to appeal to moderately conservative investors seeking greater investment returns while remaining protected against downside risk.
Index annuities offer investors the ideal combination of growth and safety when investing. Unfortunately, though, they have some restrictions such as restricting returns to a minimum guaranteed amount or limiting upside potential through participation rates that reduce potential returns significantly.
5. Limited protection
Equity-indexed annuities are designed to offer greater potential returns than fixed investments like CDs and money markets, while providing some downside protection. This type of annuity typically pays out an annual guaranteed rate (typically between 1%-3% annually) on 90% of your initial investment before investing any leftover funds in an external equity index.
An annuity’s participation rate limits how much an owner can participate in market gains, which could significantly erode potential returns.
An equity-indexed annuity offers many advantages, including tax deferral on gains accumulated within its contract and protection against market losses. Unfortunately, however, fees that could significantly diminish returns over time include surrender charges and a 10% penalty imposed for withdrawals taken before age 59 1/2.