Annuity, Equity-Indexed

What it protects against

In the accumulation phase, it protects against loss of capital due to market decline. In the distributrion phase, it protects aginst diminishment or loss of income.

How it works

Insurer invests most of the principal in bonds to ensure that the policy will generate a small annual return, but the insurer uses a small portion of the premium to buy options in stock-market index. Exercise of the options can result in additional interest credited to a policy, potentially more than an investor might achieve through other fixed-income investments.

Who needs it

Particularly well-suited for people near or in retirement who cannot afford to lose money due to stock-market declines. In taxable accounts, these products provide tax deferral that should reduce annual taxable income, a feature especially useful to those in high tax brackets. The product can be converted through the annuitization option to a reliable stream of income that lasts a lifetime and can be of great value to people without pensions.

Who may not need it

People in low tax brackets or people with money already in tax-deferred accounts. People who already have a guaranteed retirement income stream. People with equity investments who can afford to ride out stock-market declines over protracted periods. People who may unexpectedly and immediately need their money; surrender charges can exceed 8% and commonly last for 10 years or more.

When to buy it

Withdrawals prior to age 59 1/2 are subject to a 10% federal income tax penalty. However, sheltering earnings from annual income taxes works best over a long time.

How you pay for it

Single-premium products typically are bought by people with large amounts in low-yielding fixed-income investments; periodic premiums.


Terms to Know

  • The maximum rate that the equity-indexed annuity can be credited in a year. If a contract has an upper limit, or cap, of 7% and the index linked to the annuity gained 7.2%, only 7% would be credited to the annuity.
  • There are at least 35 interest-crediting methods that insurers use. They usually involve some combination of point-to-point, annual reset, yield spread, averaging, or high water mark.
  • In equity-indexed annuities, a participation rate determines how much of the gain in the index will be credited to the annuity. For example, the insurance company may set the participation rate at 80%, which means the annuity would only be credited with 80% of the gain experienced by the index.
  • A set amount of time during which you have to keep the majority of your money in an annuity contract. Most surrender periods last from five to 10 years. Most contracts will allow you to take out at least 10% a year of the accumulated value of the account, even during the surrender period. If you take out more than that 10%, you will have to pay a surrender charge on the amount that you have withdrawn above that 10%.

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