Are Equity-Indexed Annuities Riskier?
An equity-indexed annuity (also referred to as an indexed or fixed index annuity) is an insurance product that allows you to share in stock market gains without taking on direct risk. Unfortunately, however, these annuities contain complex structures with many moving parts that may be difficult to comprehend.
Participation rates play an integral part of investing, as they determine how much of an increase in market indexes is credited back to your account.
Guaranteed Minimum Returns
Indexed annuities typically track market indices like the S&P 500. When this index moves higher, so will your annuity – though perhaps not as significantly due to how gains are calculated without taking dividend payments into account.
Gains may also be limited in order to protect against declining markets during early retirement when withdrawals could cause it to be depleted quicker than planned – known as sequence risk.
Indexed annuities provide another layer of protection from downside risk, making them ideal for those less inclined to take risks but still looking for reliable ways to generate income in retirement.
As can be seen, equity-indexed annuities offer the promise of market-linked growth with principal protection, but because they can be complex products it is recommended that prospective purchasers consult a fee-only financial advisor prior to making a purchase decision.
Indexed annuities typically provide investors with a moderate interest rate and gains tied to stock market indexes such as the Standard & Poor’s 500. Investors hope that with limited or no risk to principal, indexed annuities may provide higher investment returns than certificates of deposit, money market funds or bonds.
Limits, participation rates and other factors limit how much of an annuity increase will be credited back into your account. For instance, if the index to which your annuity is tied increases by 10% in one year, only 8% would be credited back depending on your selected participation rate.
Caps can reduce monthly investment returns below those offered by equity investments – this phenomenon is known as “cap drag.” In this study, I assumed that an annuity’s 3% monthly cap was binding (i.e. reduced its return) nearly one third of the time; approximately 151/180 months saw its cap reduced the annuity’s return by this amount.
EIAs allow investors to capitalize on the market’s upside while protecting themselves from its downside. EIAs may provide greater returns than CDs, money markets or bonds while still protecting principal; an EIA may be your ideal solution.
EIA returns are comprised of both guaranteed minimum returns and any potential index-linked gains linked to an index, most often the S&P 500 index; some providers may offer other choices. Each year, this index is recalculated so any gains credited during bad years cannot be reduced by future negative index returns.
However, you should remember that an EIA’s effectiveness depends upon its issuer company’s financial strength; thus it’s vitally important that an EIA fits into your overall retirement plan and consult a professional who can devise a comprehensive approach suited specifically to meet your unique needs and objectives.
Indexed annuities provide both guaranteed minimum returns as well as potential investment returns tied to market index performance. Your market-related return depends on which index the annuity is tied to, the investments it holds and how much of any index gain they pass along – some annuities use something called a participation rate to determine how much index gain they’ll pass along to you.
As with fixed annuities, index annuities offer tax-deferred earnings, meaning the interest you earn doesn’t get taxed until it is withdrawn. This may make index annuities an excellent addition to your retirement savings plan; however it is essential that you consult a financial representative to formulate a personalized retirement strategy tailored specifically to you and your goals. Your representative can help determine which types of annuities will work best with other products as well as explain any associated risks.