Equity Indexed Annuities, commonly referred to as fixed indexed annuities, are financial products which offer potential returns based on stock market indices like the S&P 500. Although EIAs offer minimum guaranteed interest rate as well as potential opportunities in market gains, Equity Indexed Annuities contain inherent risks and complexity; prior to investing in one it’s vital that one fully understands this investment option and potential pitfalls.
Complexity
EIAs have often been criticized for being overly complex. Understanding their formula for calculating returns may be challenging and may involve participation rates, spreads and caps which all can have significant bearing on what investors might experience as returns.
Even when stock markets surge, investors in EIAs may not experience all its rewards. Many EIAs impose an annual maximum rate of return that limits how much an investor can gain during any given time period regardless of how the stock index performs.
Limited Upside
An investor’s potential gains typically are restricted to a percentage of any gain made on his chosen stock index, for instance if this index rises 10% and participation rate of an investor was at 80% he would only experience an gain of approximately 8% of that increase in stock price.
Participation Rates
Not all of a stock index’s gain will always be credited back into annuity account value; rather, participation rate determines what portion will be. For example if set at 80% and stock gains 10% then only 8 % would be credited as gain to account value.
Fees and Charges EIAs often incur fees and charges that reduce potential gains; such costs might include surrender charges, annual fees or charges related to riders or additional features.
Though most EIAs offer some sort of limited loss protection, it’s crucial that investors fully comprehend its nuances. Some products guarantee principal protection but only after certain number of years elapse since inception of an annuity contract.
Surrender Periods
Many EIAs feature lengthy surrender periods, imposing large surrender charges when withdrawals occur before their specified period expires – this makes these investments less liquid than others.
Opportunity Cost
By opting for EIA investments, investors risk forgoing other potentially more rewarding investment options with lower guaranteed minimum returns than comparable fixed income securities.
Limited Dividend Participation is currently only allowed.
Most exchange-traded funds don’t take dividends into account when calculating returns based on stock indices; since dividends often make up a considerable share of long-term investors’ returns, this can be seen as a serious drawback.
Due to the lucrative commissions associated with EIA sales, some unscrupulous financial advisors may push these products more aggressively–even when it isn’t necessarily in investors’ best interest.
Equity Indexed Annuities may be appropriate for investors seeking minimum guarantees with potential market-linked growth potential, yet also with complex structures and limitations associated with them. Because these products involve many complexities and restrictions, potential investors should carefully understand them, seek professional advice when necessary and prioritize financial goals, risk tolerance levels, investment horizon and return expectations when making any decision about Equity Indexed Annuities.