Are Equity-Indexed Annuities Riskier?
Equity-indexed annuities are deferred annuities that allow their owners to gain interest from stock market indexes like the S&P 500 without incurring risk or losing principal. Furthermore, these policies also offer other advantages like principal protection.
However, many indexed annuities contain caps and fees that could impede index-linked returns.
The answer is yes.
As with any financial instrument, equity-indexed annuities come with their own set of tradeoffs. It is important to understand their features and tradeoffs so you can determine whether an equity-indexed annuity would meet your specific needs.
An equity-indexed annuity’s key tradeoff is its participation rate, which determines how much of any index gain the insurer will credit to your accumulation account. For instance, if an index gains 15% over one year and you choose an 80% participation rate annuity with rate cap at 7% it would only credit 10% of that gain into your accumulation account; other models might feature spread, margin or asset fees that reduce gains even further.
Indexed annuities typically provide both rate caps and minimum returns to ensure a certain rate of return in years when the index declines, such as when an insurance company sets annual minimum returns of anywhere from 2% up to 3%. These minimum returns can range anywhere between two percent and three percent depending on which insurance company issues the contract.
Minimum rates are intended to safeguard you against the possibility that the index could fall so far that your total investment could go below zero, providing some peace of mind during periods when markets are volatile. Unfortunately, minimum rate guarantees do not protect against losing money in bear markets if index rises too rapidly and they can often be relatively small in comparison with potential bull market gains. Furthermore, because indexed annuities are competitive products it may be difficult to accurately interpret marketing materials; that is why working with an experienced financial professional when considering them can be invaluable.
The answer is no.
As equity indexed annuities have grown more popular, so have complaints against them. Some involve improper suitability and sales practices such as inappropriate recommendations, inadequate disclosure of terms in a sales presentation and undue pressure during free look period; others cite high fees including surrender charges and commissions.
Annuities come with their own set of risks, one being loss of principal due to market downturns. Equity indexed annuities offer some protection by guaranteeing some level of payback – typically between 1%-3% of premium, leaving the rest invested directly into an equities index – so even if market index drops you are less likely to experience principal loss than investing directly into it.
Equity-indexed annuities carry additional risks that include hidden fees and caps that limit returns, which may be difficult to comprehend due to complex language and contract fine print. A fixed equity indexed annuity might feature a participation rate which limits how much of an index gain will be applied toward index-linked interest calculations – for instance if your annuity’s participation rate was only 70% but your index went up 8% but participation rates only paid out 6.5%, your return would only amount to 6.5%.
One additional risk associated with tax-deferred annuities is if you withdraw any of your money prior to age 59.5, you’ll incur a 10% federal tax penalty – designed to deter premature withdrawals and potentially lose out on earnings opportunities – in addition to surrender charges of up to 20%; another reason why it’s wise to carefully research any purchase decisions you might make.
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