Equity Indexed Annuities

In a financial world filled with investment choices it may be hard to find a sound investment, especially when there is so much negativity surrounding investment practices. Now more than ever, it’s important to identify an investment as a vehicle to make a profit or to produce an income, without it costing a fortune in the process.

An investment as Webster defines it, is putting money into a business, real estate or in stock for the sole purpose of generating an income or a profit. Some segments of the financial market have taken the word investment and used it as a sales tool to increase their own assets by using cleverly concocted investment packages, which are filled with fees, deductions and fine print that hinder the investor’s ability to realize a real return. In other words, some insurance companies and financial institutions selectively define the word investment, so it is more of a money making tool for the company, rather than a sound investment for the actual investor. An equity-indexed annuity is one of those questionable investments.

Insurance companies have been selling equity-indexed annuities since 1995. An Equity-indexed annuity is an investment vehicle or contract between the investor and the insurance company. The investor can make a series of payments or one large payment to insurance company and they invest the money in an equity index and will guarantee a minimum return on the original investment. Equity-indexed annuities can be based on several different indexes like the Dow Jones Industrial Average, the New York Stock Exchange Composite index, the S&P 500 Stock Price and the Nasdaq-100 Index. The guarantee minimum return rates vary based on how the contract is written.

Equity-indexed annuities can be a losing proposition, especially if the investor wants to cancel the contract early. The contract is usually filled with surrender charges and there could also be tax penalties involved. Investors should also be aware of the other important aspect of how index-linked interest is credited. There are several features that could affect investor returns. Most equity-indexed annuities have a participation rate built into them. If there is an increase in the index and the investors participation is only 70% are the time of the increase, the investor will only be credited with 70% of the total index increase.

Some equity-indexed annuities contain an interest cap, which means there is a limit or a maximum interest rate that the annuity can earn. If an index has an increase of 8.5% and the cap is 8%, then the annuity is only credited for the 8%. Other annuities may include a percentage cost that the insurance company calls an administrative, margin or spread fee. If that fee is 2% and the index increases by 8%, the investor’s annuity is only credited with a 6% increase.

When an equity-indexed annuity and annuity rates are established, it’s important to understand how the index returns will be credited. There are three methods used to credit a return. The point to point return credits index-linked interest from the beginning of the contract to the end of the contract. A high water mark credit usually credits any increase from the beginning to the highest index value at different times during the contract which usually is annually. The other way to credit interest is to credit the investor from the beginning to the end of each year.

Even with all of those variables that affect profit, there is over 123 billion dollars invested in equity-indexed annuities. Perhaps it’s time to define investment another way. It might be called a sales tactic that might produce an income or that makes a profit, if the middleman is not too greedy.