The Equity Index Annuity Guide

The Equity Index Annuity (EIA) or Fixed Index Annuity (FIA) is an insurance product that has interest growth based on a stock market index.  The Equity Index Annuity is most commonly linked to the Standard & Poor's Composite Price Index, also known as the S&P 500 Index.  This type of structure allows the annuity owner to participate in market trends, without actually owning individual stocks.  The index is used to determine the annual interest rate that will be paid on the equity index annuity contract.

Most of the fixed index annuity contracts provide the investor with a guaranteed minimum interest rate.  In years that the market increases, the fixed index annuity grows with the growth of the index.  During down years, the guaranteed minimum interest rate kicks in.  This allows the contract owner to protect their principal from market fluctuations.

The equity index annuity can be a powerful retirement planning tool during recession years.  While the market is dropping, the principal that the annuity owner relies upon for their retirement remains protected.  When the market does turn around however, the fixed index annuity participates in the market upswings.  This can be an excellent way to participate in big market gains, while protecting against negative market volatility.

A large portion of the equity index annuity accounts available are deferred fixed annuities.  This simply means that the annuity owner makes more than one payment to the insurance company.  The payments back to the fixed index annuity beneficiary are then "deferred" for a year or more.

What resources are available to learn more about equity index annuity contacts?

There are a couple of topics that you need to research before you purchase an equity index annuity.  We've provided articles on a couple of the important topics to explore.  While it is true that these types of contracts participate in market upswings, it is important to understand that the interest rate is not on a 1:1 ratio with the index.  The insurance company will provide your account with a portion of the upswing.  They either cap the rate or provide you with a percentage of the growth.  This is explored further in the article on Equity Indexed Annuities Caps and Participation Rates.

When selecting your fixed equity index account you also must choose the interest crediting option that best fits your needs.  The two most common types are annual point to point and monthly averaging.

What are the advantages of the equity index annuity?

The primary advantage of the equity index annuity is the protection from market volatility while participating in the market upswings.  This allows the annuitant to protect the principal of their account, but also gives them the growth potential of riskier investment vehicles.  In retirement years, it is important to protect your principal and not outlive your income.  The fixed index annuity can provide this type of protection.

Most equity index annuity accounts are also tax-deferred.  Tax-deferred growth allows the annuity account values to grow at a much faster rate than vehicles taxed first.  All of the money that would normally be paid out in taxes is reinvested back into the account.  The annuitant then has this additional value building interest.

Most fixed index annuity accounts will also provide a lifetime income option.  This connects the payments on an account to the life of an individual.  As long as that individual lives, the annuity will continue to make fixed payments to the beneficiary.

What are the disadvantages of fixed index annuity accounts?

Similar to other annuity products, the equity index annuity must be customized to your specific circumstances.  Equity index annuities are not for everyone.  It is important to get sound investment advice before entering into a contract.

One of the primary concerns of annuity contracts is that they can sometimes be difficult to get your money out if you "change your mind."  The majority of equity index annuity accounts will also have an early withdrawal penalty or early surrender charge.  These charges can be steep and generally discourage extra withdrawals from the account.

Depending on the nature of the equity index account, there may also be tax penalties for withdrawals before age 59 ½.  This is because of the tax-deferred nature of some of these types of accounts.

Equity Index Annuity Summary

The Equity Index Annuity can be a powerful planning tool if used properly.  It is important to educate yourself regarding these investments.  By reading this far, you have already made a good first step.  We encourage you to read the rest of the website and be sure to investigate the different areas that you need to address regarding these equity index annuity accounts.

Equity index annuities can provide you with a secure retirement income and allow you to continue to participate in a portion of market upswings.

 

Equity Indexed Annuities Cap and Participation Rates

Equity index annuity accounts will often either have a participation rate or cap placed on the index interest rate.

With the participation rate, the insurance company only allocates a portion of the growth of the index to the annuitant.  This portion is called the participation rate.  Participation rates will generally range from 35% up to as much as 100%, though at 100% participation there is generally a cap (see below on caps).

Consider an annual point-to-point strategy on an equity-indexed annuity.  This strategy compares the S&P 500 value at the beginning of the year and the end of the year.  If the market increases 12% over this period, a 65% participation rate would credit the annuitant 7.8%.

Similar to a participation rate, a Cap is a way for the annuity company to skim off some of the bonus growth that an annuity acquires.  Many insurance companies offer an equity-indexed annuity strategy that has 100% participation in market upswings, but places a Cap, or maximum interest rate that the annuitant can acquire.  The Cap is simply that, a maximum rate that the insurance company is willing to pay.

If an insurance company has a Cap of 6%, and the market increases 11%, the annuitant will only enjoy market increases of the 6%.  These accounts will generally have a minimum interest rate as well, and will almost never allow a negative interest rate.  This permits the equity index annuity owner to enjoy protection of capital, as well as participation in market upswings.

The reason that the insurance company only allows a portion of the growth is so that they may offset the losses they receive when the market decreases.

 

Annual Point to Point and Annual Reset Provisions

Another equity index annuity crediting option is the annual point to point.  The value of the interest added to the account is simply determined by the growth from one point in the year to another.  The first point is generally the S&P 500 value at the start of your contract, with the end point as the last S&P 500 value at one year's period of time.  The equity index annuity account then has an annual reset provision starting the process over again.

An annual point to point contract allows for the previous year's market performance to not affect the performance of the account in future years. The interest earned by the market performance is added to the account on a yearly basis.  In years in which the market increases in value, the equity index account is credited a portion of that growth (see Equity Indexed Annuities Cap and Participation Rates to learn why only a portion is credited).

When the market is down for the year, rather than decrease the value of the account, the fixed index annuity simply reverts to the minimum pre-determined interest rate (can be as low as 0%).  This allows you to protect your principal, but also participate in years in which the market is up.

 

What is the S&P 500 Index?

The Standard & Poor's Composite Price Index is a world-renowned index that is commonly regarded as the single best measure of the current United States equity market.  The S&P 500 Index is made up of 500 leading companies in most of the leading industries in the United States.

The S&P 500 covers approximately 75% of all of the U.S. equities market.  The vast majority of equity index annuity products use the S&P 500 index to link their interest rates.

 

Monthly Averaging Interest Crediting Option

Different equity index annuity accounts will credit the interest accrued by the index differently.  One common method of determining the interest rate is monthly averaging.  Monthly averaging smoothes the volatility of market interest rates, leveling out the upward and downward movements of the market.

The smoothing effect allows you to minimize the effect of big market drops.  On the other hand, this also reduces the benefits of large market upswings.  By averaging, you also position yourself at a disadvantage if the market increasing continually for multiple years.  The equity interest rate that you are receiving on your indexed annuity account will be lowered by such a market movement.

Many annuity contracts will provide you the option of either a participation rate or cap.  See Equity Indexed Annuities Cap and Participation Rates for more information, or refer to the main page on equity index annuity accounts.