• Investment Offerings
  • Equity-Indexed Annuities

    by Cara Scatizzi

    Equity Indexed Annuities Splash image

    Sales of equity-indexed annuities topped $30 billion last year, according to Investment News. These investment products offer rates of returns based on the performance of an index.

    How Annuities Work

    An annuity is a contract purchased from a life insurance company that provides a stream of payments or income for a set length of time.

    There are two main types of annuities. Deferred annuities allow investors to put away money on a tax-deferred basis so the entire investment can grow tax-free until withdrawals are taken in the future.

    An immediate annuity has no accumulation period. The investor pays the insurance company a lump sum and receives a stream of payments immediately (within 12 months).

    Both deferred and immediate annuities pay rates of return based on three different options. Fixed rates of return are set and remain unchanged during the annuity life. Variable rates may change depending on the performance of stocks, bonds and mutual funds. Index rates are based on the performance of an underlying index.

    How Equity-Indexed Annuities Work

    Equity-indexed annuities make payments based on an interest rate linked to the performance of an underlying stock market index. Typically, indexed annuities guarantee a minimum interest rate and restrict the maximum percentage of interest that can be earned.

    The maximum level is determined by a participation rate, spread, or interest rate cap. For example, a participation rate of 85% would mean that if the underlying index rose 10% in a year, the annuity holder will receive only 8.5%. Be aware that some issuers will reserve the right to change the participation rate throughout the annuity’s life. (An interest rate cap places a maximum limit on the return.)

    Equity-indexed annuities also guarantee no loss in principal, though a significant fee exists if the policy is surrendered early.

    The annuity will charge maintenance and/or management fees that reduce the rate of return as well.

    How to Invest

    Annuities are sold by a variety of insurance and investment firms. Types vary so be sure to comparison-shop for the best annuity for your circumstances. You can find a list of current annuity rates at www.indexannuity.org by choosing Current Rates.

    Speaking with an investment advisor who does not benefit from your annuity choice is important when shopping for an annuity.


    Deferred annuity payments are tax-deferred, meaning you pay taxes on earnings when you withdraw funds.

    Payments from immediate annuities are taxed at the rate of ordinary income when the money is received.

    The Pros

    Potentially Higher Returns

    Compared to fixed annuities, equity-indexed annuities offer a way to participate in stock market gains while still guaranteeing a minimum positive return should stock prices fall.

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    Guaranteed Stream of Income

    For retirees worried about running out of money, an equity-indexed annuity can provide a steady stream of income or a guaranteed lump-sum payment at a future date.

    Minimum Return Guarantee

    Equity-indexed annuities guarantee that your principal payment will not lose value even if the underlying index falls.

    The Cons

    Lower Returns

    If the underlying stock index performs better than the minimum rate of return, the annuity holder will not fully participate in the market rally. Furthermore, if a cap exists, the difference in returns could be significant, especially during a bull market. A cap means that your gains are limited by the initial contract regardless of how well the index performs.

    Money Is Locked In

    Your money is locked in. The deferred annuity will not pay out the lump sum until the specified date. If you need to withdraw the money before the specified end date, you will pay high fees and penalties.

    Cara Scatizzi is a former associate financial analyst at AAII.


    Allan Schilling from FL posted over 5 years ago:


    There have been general articles on annuities. When I do a search, I come up with an article on Equity annuities. Are there any other articles? I am looking for a a general explanation of annuities.


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