Equity Indexed Annuities

Sales of equity-indexed annuities (EIAs) have skyrocketed in recent years and for some investors, the results haven't been pretty. In the past, these products have been described by as simple investments, but in reality they are anything but that.

Equity-indexed annuities (EIAs) have been around since the mid-1990s. They are considered an exotic variation of either a deferred or immediate annuity in which returns are tied to a stock-market index such as the S&P 500. Because the value of any index varies from day to day and is not predictable, equity-indexed annuities also have more risk than some other types of annuities.

Variable Annuities

An indexed annuity may or may not be a security; however, most indexed annuities are not registered with the Securities and Exchange Commission (SEC). When you buy an equity-indexed annuity, you are not buying shares of any stock of index. Rather, you essentially own an insurance contract.

One of the ways an equity-indexed annuity is different from other fixed annuities is the way it credits interest to the annuity's value. The Financial Industry Regulatory Authority (FINRA) highlighted this feature in a recent investor alert on equity-indexed annuities. Among other things, FINRA states that one of the most confusing aspects of an EIA is the method used to calculate the gain in the index to which the annuity is linked. To make matters worse, there are several different indexing methods. Because of the variety and complexity of the methods used to credit interest, investors are often unable to compare one EIA to another.

EIAs are long-term investments. Getting out early may mean taking a loss. Most EIAs have surrender charges. The surrender charge can be a percentage of the amount withdrawn or a reduction in the interest rate credited to the EIA. Also, any withdrawals taken from tax-deferred annuities before the age of 59½ are generally subject to a 10% tax penalty in addition to any gain being taxed as ordinary income.

Before investing in an equity-indexed annuity, it's important to carefully consider your own personal financial picture and your short- and long-term investment objectives. There are features and trade-offs unique to equity-indexed annuities, including the fact it is impossible to predict the future market behavior of an index.