Equity Indexed Annuity
Equity-indexed annuities are complex insurance contracts whose returns are linked to the stock market. They often come with hard sales pitches and high commissions for sellers. Should you invest in one? Possibly. But it takes a lot of work to get past the sales hype and sort out the details.
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Like all fixed annuities, EIAs are contracts with an insurance company. They pay interest until you begin withdrawing regular payments. Those payments are based on the value of your account, current rates and the payout period.
Equity-indexed annuities have a minimum fixed interest rate, but they offer the potential to earn more with a variable rate that's based on the performance of a stock index, such as the Standard & Poor's 500.
The insurance company determines how much of the index's gain goes to your account. For example, some companies will give you a rate equal to 80% of the gain in the index. If the S&P 500 gains 10% in a year, you'd earn 8%.
Others apply a spread, or margin. If the spread on your EIA is 3%, for example, and the S&P 500 gained 10%, you'd earn 7%.
There also might be caps on an EIA: If the S&P 500 soars 20% and your cap is 9%, you'd be credited with 9%.
If that's not confusing enough, this cap could change every year. And companies might credit your account at different times, which could affect how quickly the balance grows. Forty-one companies currently offer 130 different EIA products, according to Advantage Compendium in St. Louis. That's why investors need to shop around.
EIAs are not without risks. If you withdraw money in the first years of the contract, you might have to pay substantial penalties, called surrender fees. You can lose money if you take early withdrawals.
Because surrender charges can apply for more than a decade, EIAs might not be suitable for elderly investors.
If you make a withdrawal before you reach the age of 591/2, you'll generally pay a 10% tax penalty as well as owing income taxes on your gains.
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Also, most EIAs ignore dividend returns from the index on which they are based. Dividends add about 2 percentage points to the stock market's returns.
Consumers might have difficulty figuring out total fees for EIAs, because insurers don't usually don't break out that information. Companies take fees into account before offering buyers a percentage of the index's gains. Generally, the lower the rate, the higher the fees. Most EIAs aren't considered securities, so they're regulated by state insurance commissions, rather than by the Securities and Exchange Commission or the NASD.
The National Association for Fixed Annuities, a trade group, says state regulation is appropriate for EIAs because they are insurance policies. Consumers aren't putting money directly into the underlying index. Companies put the money into their general accounts, then invest it to give clients a minimum guarantee and a percentage of the index's gains. Others think the products need greater regulation.
"EIA returns are variable. They are clearly a security. But they have been able to be characterized as a fixed product and avoid NASD supervision," says Vince Micciche, chief executive of LifeMark Securities.
Source: usatoday.com - 08-11-2005
