These days it seems investors are looking for safety and security more than ever, especially after the major stock market correction witnessed from 1999-2002˳ Four years later, numerous brokerage and variable annuity accounts still have not recovered their losses from that time period˳ Unfortunately, many investors were counting on those funds to provide income during their retirements˳
Thus the introduction of the equity indexed annuity, or EIA, to the main stream marketplace˳ Designed to provide a greater return than the traditional fixed annuity, the equity indexed annuity can be a reliable alternative to a brokerage account˳ Only fifteen years old, several billion dollars have been deposited into these accounts˳
Annuities in General
First, a potential investor should have a little background information˳ Generally, an annuity functions in the following manner: The investor, usually called an owner or annuitant, agrees to deposit funds with an insurance company for a specified period of time, say 7 years˳ The annuity is said to be in deferral during that period of time˳ While in deferral, most annuities will allow for partial distributions of interest gains or a yearly 10% free withdrawal or the required minimum distribution mandated by the I˳R˳S˳ (Many annuities allow for larger distributions if the owner is confined to a nursing home or is terminally ill˳) Still another way to distribute annuity dollars is through a systematic withdrawal, referred to as an annuitization, based on a pre-determined schedule, say 5 years˳ However, if the consumer decides to take the entire contract out as a lump sum before the annuity has matured, then penalties are invoked based on the surrender schedule in the annuity contract˳ If the investor passes away, the lump sum of the annuity is paid to a beneficiary at passing unless other arrangements have been made˳
Technically, equity indexed annuities are characterized as fixed annuities by the various Departments of Insurance in each state˳ That is to say, at no point does the investor ever own any variable type of security like a stock, bond or mutual fund within the EIA account˳ These accounts do not fluctuate in value like a variable annuity might˳ Yet the equity indexed annuity is not like your typical fixed annuity either˳
The Equity Indexed Annuity Advantage
What makes EIAs different than a traditional fixed annuity is how interest is credited to the account˳ Typically, the insurance company will buy an option in a particular index like the DOW, S&P 500 or the NASDAQ˳ After a period of time, usually one year, the option contract comes due˳ One of two things will then occur˳ If the market index has advanced, the option is cashed in and interest is credited to the annuity principal˳ Conversely, if the market has retreated, the option expires and no interest is credited to the account for that year˳
In practice, the annuity either gains or maintains value each year, but the investment cannot lose value due to negative market fluctuation˳ (It is also important to note that all EIAs have a minimum guarantee associated with their returns˳ For example, this guarantee might state that if the market declines every year over the life of the annuity, the insurance company will guarantee payment of 2% on 88% of the premium deposited˳ However, it is practically unheard of for this safety feature to be utilized˳) Investors should also know that most equity-indexed annuities have a fixed interest account as an additional investment option˳ When interest rates are high and the stock market is in decline, the fixed account might be used to credit interest to the annuity principal˳
Equity Index Performance
How do these annuities perform? Historically many of these accounts have averaged returns of 7% or better˳ In years when the broader markets have performed well so have EIAs˳ It is not uncommon for investors to enjoy interest payments during these prosperous years of 10-20% or better˳ But the crucial value of these accounts is realized during rapid market declines, when the equity indexed annuity will maintain its principal as well as interest gains from past years˳
These facts may explain the recent popularity of EIAs, especially among retirees looking to preserve a lifetime’s worth of hard work˳ With the market advancing and declining so rapidly, many consumers are looking for safety and security without having to sacrifice reasonable interest returns˳ Granted, these annuities will not return 50% in one year, like a fortunate stock or fund pick might, but the peace of mind investors gain knowing their investment cannot decline has many placing a portion of their retirement funds into these accounts˳
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