Equity Indexed Annuities

Equity-indexed annuities are a type of fixed annuity. They get their name because their interest is partially based on an equities index, such as the S&P 500. They provide an opportunity for higher returns than traditional indexed annuities provide. But they still provide the same risk protection. In this article, we will go over the basics of equity-indexed annuities.

How They Work

Equity-indexed annuities are contracts with an insurance company. Unlike fixed annuities, part of the interest rate is based on a specific equities index, like the S&P 500. While the other part is a guaranteed minimum of between 1% and 3%. Like all annuities, equity-indexed annuities have an accumulation period where the money you paid initially earns interest. The amount of interest you earn will be based on one of three calculations.

3 Equity Index Calculations

Your policy will use one of three calculations to determine the amount of interest you will receive based on the equity index. The first and most common is the annual reset formula. This formula only looks at the indexes gains, but not the declines. The second is point-to-point. With this calculation, they take the rate of return from two times in the year and average them. Third is the high-water mark calculation. This takes the index values at the anniversary date of the policy. They take the highest index value and average it with the value at the beginning of the payment term.

Special Considerations and Limitations

As with all investment vehicles, there are additional things you need to consider before purchasing an equity-indexed annuity. First, they have a participation rate. This will limit the extent you can earn on a market gain. For example, let’s say you have an 80% participation rate. Your equities index you are tied to makes a 15% profit; you would only realize a 12% profit in your account. However, you do have protection again the risk of losses.

Second, you need to be aware of surrender charges. Annuities have a period during which if you take a withdrawal of more than a certain percentage you will be penalized for it. This is an investment for those with a long time horizon, not a short one.

Purchasing Equity Indexed Annuities

This is meant to be a very basic introduction to equity-indexed annuities. You will want to meet with a qualified agent and financial planner who can help you better understand your purchase and help you find the best policy for your needs.

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