What is the Greatest Disadvantage of an Equity-Indexed Annuity?
Indexed annuities differ from traditional fixed annuities by offering the potential for market-linked returns. They often tie back to well-known indexes and include performance caps.
These caps limit your potential gains during years when the index rises, as well as participation rate and interest rate caps (and spread, margin or asset fees), which limit how much of an index increase you receive.
1. It’s not a direct investment in the stock market
If you are considering investing in an equity-indexed annuity, take care to thoroughly educate yourself on the product before making your decisions. Researching equity-indexed annuities may be more complex due to salespeople using gimmicks and hype as part of their selling pitch.
Some indexed annuities provide protection from market downturns by setting an upper floor or buffer which limits how much value can be lost by the insurance company, thus decreasing your risk of losing all your principal investment.
As well, some annuities may place limits on how much index-linked interest will be credited back to your account on each contract anniversary date; this could impede performance if an index increases suddenly near either start or end of term.
Additionally, some indexed annuities only credit a percentage of the increase in an index’s value; this could significantly diminish your returns and could have an enormous effect on how quickly your annuity account balance grows.
2. It’s not a guaranteed return
If you prefer managing your investments yourself but wish to participate in stock market increases while protecting yourself from downturns, an index annuity might be the right product for you. But be mindful that they do not guarantee an assured return.
Indexed annuities tend to come with caps and participation rates that limit potential gains. For instance, an index may experience 15% gains; the insurance company might only credit your account with 80% of this profit.
As with annuities, insurance companies also often deduct a spread/margin/asset fee from the index-linked returns they credit annuities with, which can significantly diminish potential returns.
3. It’s not a tax-deferred investment
An equity-indexed annuity is a retirement investment with either fixed or variable payout rates for an established period, offering both stability and potential upside. But like any investment, equity-indexed annuities come with their own set of risks that should be carefully considered before investing.
An equity-indexed annuity offers investors a way to participate in market index gains without taking on its associated risk.
An annuity’s index-linked interest is paid each year based on its contract specifics known as participation rate. However, this calculation typically does not take dividends into account which can make up up to 40% of total market return.
An annuity also typically offers a guaranteed minimum return that’s higher than the current index-linked interest rate, helping protect you against losses during a downturn and being one of the reasons many choose this form of supplementing retirement savings with them.
4. It’s not a guaranteed minimum return
Equity index annuities offer an attractive combination of market-linked growth potential and principal protection, but should not be the primary source of your retirement income. They usually come with tradeoffs that must be carefully considered.
An annuity offers several unique protection features, such as its maximum index-linked interest rate. This prevents sudden drops in value caused by declines in an index that could threaten to reduce earnings over time.
An annuity’s participation rate determines how much of any increase in an index used to calculate index-linked interest will be credited back to you; for instance, if it increased 10% but your participation rate is 70% only 7% would go toward crediting back into your annuity each year – the rest going toward spread/margin/asset fees of the annuity itself.
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