An equity linked indexed annuity is a contract between a person and an insurance company in which the insurance company contractually promises to make periodic payments to the owner of the annuity. In equity indexed annuities, the invested principal and contractual minimum interest rate are guaranteed or fixed, but the annuity’s annual return or crediting rate (yield) is linked to a market index.
The feature separating equity index annuities from standard interest bearing annuities is how the account’s interest is credited. Indexed fixed annuities normally offer a minimum guaranteed interest rate combined with an interest rate linked to a market index such as the Standard and Poor’s 500 or the Dow Jones Industrial Average.
Because of the equity index annuity’s guaranteed interest rate, fixed equity indexed annuities have no market risk other than the expected interest credited to the annuity, which is determined by the outside source. In a fixed index equity annuity, the deposited funds are never at risk and are fully guaranteed to the annuity owner.
The guaranteed minimum return varies according to state of residence and option chosen as the best index annuity according to the individual’s needs, but a reasonable expectation is 2-3% of the account value. The equity indexed annuity could earn more based on the crediting rate returns, but never less than the fixed guaranteed minimum.
Equity Indexed and Fixed Annuities: Pros and Cons
Indexed annuity pros and cons differ. The best equity indexed annuities are the fixed index annuities which fit the annuitant’s specific needs and goals. Contracts and crediting schedules vary greatly between companies and between annuity products.
• Participation Rates:
A participation rate determines how much of the gain in the index will be credited to the equity linked indexed annuity. As an example, an insurance company may set the participation rate at 80%, meaning the index annuity is only credited with 80% of the gain experienced by the index.
• Asset Fee:
Some fixed equity indexed annuities use an asset fee instead of a participation rate. This percentage is subtracted from any gain in the index linked to the annuity. For example, if the crediting index gained 12% and the percentage asset fee is 2%, then the gain in the index annuity would be 10%.
• Interest Rate Caps:
Some equity indexed annuities use a cap to limit the annuities’ crediting gain. This cap rate generally is in lieu of an asset fee and states the maximum an annuity can return in any one year. If the crediting rate is 10% but the cap is 7%, then the return is 7%.
• Earned Interest:
Some equity indexed annuities have an interest only option. This means that instead of a crediting rate tied to an outside source, the annuity simply pays a previously agreed upon interest rate, such as 5%.
Other benefits offered by a fixed equity indexed annuities:
• Freedom from probate expenses
can be enjoyed by naming a beneficiary. A named beneficiary will receive the funds immediately and without delay in the event of the annuitant’s death.
• Lifetime Guaranteed Income.
Fixed equity indexed annuities can provide income for any time period, even a lifetime. This safe, secure reoccurring income can reduce stressful concerns over future financial insecurity.
• No risk.
Fixed indexed annuities are guarantee deposits, with no risk to the original deposit or beginning annuity value.
• Auto-Pilot Investing:
Indexed linked annuities are like having your funds on auto pilot. You only participate with the bulls (increase) and never hide with the bears (decreasing). Here is another way of looking at it….
“How would you feel about gambling if you went to Las Vegas and played blackjack? The situation is if you won a hand you got the money but if you lost to the house, you kept your bet, you didn’t lose. That is what indexed annuities, you only can increase and you have no exposure to loss.”
As with all major decisions make certain you understand the contract, any tax issues or other things specific to your personal situation.
Disclaimer: Annuities are not for everyone; make sure you understand the individual fixed equity indexed annuity’s pros and cons in order to choose the best equity indexed annuity for the individual annuitant, considering the equity indexed annuity’s contractual limitations and benefits.
“Standard & Poor’s”, “S&P 500”, “Standard & Poor’s 500” and “500” are trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use by companies offering Equity Index Annuities. The product is not sponsored, endorsed, sold or promoted by Standard & Poor’s and Standard & Poor’s makes no representations regarding the advisability of purchasing the product.