Are Equity-Indexed Annuities Riskier?
Many investors are drawn to equity-indexed annuities because of their promise of reduced market volatility, yet these products can be complex with returns being limited by caps and participation rates.
Retirement savings products like an annuity are popular with retirees and near-retirees who can’t risk having their savings evaporate in an unfavorable market downturn, but these policies come at a cost.
If you are seeking a safe investment that offers higher returns than CDs or money market accounts, an equity-indexed annuity could be worth exploring. Regulated by state insurance commissions and providing protection from downside risk, these investments can be complex to understand and often include caps and participation rates that limit potential investor gains.
Equity-indexed annuities, commonly referred to as indexed or fixed indexed annuities, have come under fire for their high fees and opaque nature, yet remain popular with investors looking for guaranteed minimum returns plus the opportunity to benefit from stock-market gains. A key feature of these annuities is tax deferral similar to IRAs and 401(k)s; any gains earned will remain tax-free until withdrawal takes place.
An equity-indexed annuity offers guaranteed returns that could potentially outstrip market returns, making them ideal as part of retirement savings plans.
An annuity company’s calculation of your index-linked interest depends on how your contract is structured. One key element to be aware of is your participation rate, which determines how much of the index-linked interest will be credited towards your annuity.
Consideration should also be given to index term and participation rate cap; respectively, these factors measure an index’s growth over time, while participation rate caps limit how much gain you can experience each year.
An equity-indexed annuity combines features from fixed and variable annuities. It guarantees a minimum rate of return tied to stock market index performance such as the S&P 500. In addition, there is an annuitization period which enables principal and earned interest payments over a specified time period to be annuitized tax-deferred and bypass probate proceedings.
Index annuity returns are determined by how well an index performs as well as any contractual limitations, such as participation rates, spread fees, caps and fees. A capped index annuity might only credit up to 80% of an index’s gains while most indexed annuities also exclude dividends which could erode your overall returns.
An indexed annuity offers some protection from risk by setting a floor that caps how much money can be lost during any down year and offering participation rates that credit only a portion of index returns rather than providing full access to them.
However, these limitations can be offset by the fact that indexed annuities are backed by the insurance company that offers them. If it goes out of business unexpectedly and your money goes with it, this could result in the loss of some or all of it.
Risks associated with an indexed annuity should be carefully considered when purchasing one. Before making your choice, review all options with an experienced financial professional and pose any inquiries that arise regarding anything unclear to you.
Equity-indexed annuities differ from traditional fixed annuities by offering an annuity component that earns interest based on market indexes. They tend to appeal to moderately conservative investors looking for investment growth potential while seeking protection against downside risk.
EIAs can provide returns up to 15% higher than bank CDs over seven to 10 years, however you should consider what amount could be lost should the market decline – this is known as setting up a floor or buffer.
Your investment return depends on a variety of factors, such as participation rate, spread or margin/asset fees and other fees that could reduce actual returns significantly. Furthermore, annuities typically impose surrender charges if you withdraw them prior to age 59 1/2.
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