An equity-indexed annuity is a type of fixed annuity that earns interest based on a portion of an equities index, typically the S&P 500. An index equity annuity is also known as a fixed index annuity.
Equity-indexed annuities appeal to many people, especially those who want some opportunity to earn a higher return than what’s available with traditional fixed-rate annuities but still want protection should things go wrong.
How an Equity-Indexed Annuity Works
An annuity is an insurance policy for retirement with an insurance company. There is an accumulation period where the policy earns interest. At the end of the accumulation period, the investor has full control of the initial investment and earned interest. In addition, there is an optional payout period called annuitization.
Equity-indexed annuities provide a guaranteed minimum interest rate, typically 1% to 3% paid on 87.5% of your investment. This minimum interest rate applies if an investor earns no returns over the course of the contract. Thus, the primary method of earning interest is linked to the performance of an external equities index.
Earnings from index equity annuities are usually higher than traditional fixed-rate annuities, lower than variable-rate annuities, but with better downside protection than a variable annuity.
Earning Interest on Equity-Indexed Annuities
Indexed equity annuities offer a participation rate that can limit the extent to which the annuity owner can participate in market gains.
In exchange for limited profits, investors receive protection against downside risk, breaking even each year a down market occurs.
Some annuities have a cap on the total interest they can earn.
Annuities that use indexed funds (funds with changes based on market performance) have calculation formulas to measure performance. The annual reset formula looks at the index gains without considering any declines, which can benefit during “down years” in the stock market.
Equity-Indexed Annuities Disadvantage
The primary disadvantage of equity-indexed annuities is surrender charges. If the annuity owner decides to cancel the annuity, cancellation penalties can be high. In addition, accessing the funds before the age of 59½ will be subject to a 10% tax penalty.
Equity Indexed Annuities Pros and Cons
| Pros | Cons |
|---|---|
| No Contribution Limits | Long-Term Contracts |
| Guarantee On Investment | Surrender Charges |
| Tax-Deferred or Tax-Free Growth | Additional Fees |
| Pass Down to Beneficiaries | Tax Penalties If Withdrawn Too Early |
| Spousal Continuance | Limited Upside Potential |
| Stock Market Volatility Protection | Caps and Rates Can Be Lowered |
| Guaranteed lifetime Income | Limited Liquidity |
| Helps To Pay For Long-Term Care | |
| Life Insurance Alternative |
Equity Indexed Annuity Quotes
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