An equity-indexed annuity (EIA) is an alternative savings plan for conservative investors. It can come as an immediate or deferred annuity, so the periodic payments promised in the contract are delayed. An investor may take on more risk compared to fixed or variable annuities. The returns are linked to the performance of a particular stock market index, often the S&P 500 or the Dow Jones Industrial Average (DJIA). The performance also depends on the terms of the contract. However, these instruments have the benefit of more potential return while providing the traditional benefits of being an annuity. (For a background reading, check out An Overview Of Annuities.)

EIA History
These annuities came onto the scene in the 1990s, and have been sold at insurance companies. They follow the rise in stock market values, and are considered an investment that could help seniors, who were able to ensure that their money was protected and growing, with their retirement income needs.

The investment tool's popularity soon took off at the turn of the millennium, with sales in the billions. The industry changed and the annuities became more complex. The tools had a variety of fees and charges, limitations on accumulation, calculations of index values, along with some other features.

Between 2003 and 2004 alone, sales doubled, going from $14 billion to nearly $22 billion, respectively. Sales were nearly $25 billion in 2007. In June of 2008, more than $123 billion was invested in indexed annuities, Christopher Cox, Chairman of the Securities and Exchange Commission stated at the time. Sales increased 45% in the first six months of 2009.

In 2008, the Securities Exchange Commission cracked down on the abusive sales practices used to promote the product to seniors. An inquiry at a national seniors summit revealed that EIAs were among the securities involved in senior investment fraud. The SEC worked on a new rule that would consider EIAs securities, and therefore would have protections afforded by the securities law.

EIAs Differ from the Other Types of Annuities
An EIA's return is more interchangeable than a fixed annuity's, according to Financial Industry Regulatory Authority (FINRA), but this isn't the case when compared to a variable annuity, the return is not as much. The guaranteed interest rate is at a minimum; although, it's combined with an interest rate linked to a market index. It's the guaranteed interest rate that lessens their market risk; this differs from variable annuities. Also, when the stock market rises, these investments are likely to have more gains than traditional fixed annuities. (To learn more see How Does FINRA Differ From The SEC?)

The most common features that impact the return on equity-linked annuities are the participation rates, the spread, margin and asset fee, and the interest rate caps. Participation rates determine the amount of gain in the index that will be credited to the annuity. This would mean, for example, that if an insurance company sets the participation rate at 90%, the annuity would only be credited 90% of the gain.

A spread, margin or asset fee in addition to, or instead of, a participation rate are sometimes used with these types of annuities, and the percentage will be taken away from any gain in the index linked to the annuity, according to FINRA. Some EIAs will restrict the upper limit on your return, according to FINRA.

The typical methods in which the equity insurance annuities are calculated include the annual reset method, the point-to-point method and the high-water-mark method. The annual rest method looks at the changes in the index from the beginning to the end of the year, while neglecting declines; the point-to-point method looks at the change in the index at two points in time; the high-water mark approach narrows in on the index value at typically the annual anniversaries and takes the highest of these values and compares it to the index level at the start of the term. (To learn more, check out Make No-Load Annuities Your Viable Alternative.)

  • Advantages
    The guaranteed minimum return for an equity insurance annuity, FINRA found, is typically 90% of the premium paid at a 3% annual interest rate. However, make sure the insurance company is able to meet its obligation by finding out how it is rated among others in the industry. Additional perks of this investment are that it credits interest on the anniversary date of the annuity, and it offers tax-deferred growth.

  • Disadvantages
    If you surrender the equity investment annuity early, you face a tax penalty of 10%, but the real clincher for investors has been the high surrender charges. The charges may whittle down to zero within 15 years, but if the investor needs to access to the money sooner for medical expenses or rent, they can be slapped with a fee between 15-20% of the amounts that they invested. Huge commissions have been a part of abusive sales. Commission fees charged were as high as 13%. Also, keep in mind that the money will be locked away for several years and the instruments are not regulated.

Conclusion
EIAs are fairly complex, so make sure you understand and ask about the features in these annuities with your broker. Find out about the participation rate, how long it's guaranteed for and whether the contract has a cap. Also, examine the insurance company involved. Check with your state's insurance department and take your time determining whether this investment is right for you. (For more, see Annuities: How To Find The Right One For You.)

Related Articles
  1. Investing Basics

    What's a Treasury Note?

    A treasury note is a U.S. government debt security that offers a fixed interest rate and a maturity date that ranges between one and 10 years.
  2. Investing

    Five Things to Consider Now for Your 401(k)

    If you can’t stand still, when it comes to checking your 401 (k) balance, focus on these 5 steps to help channel your worries in a more productive manner.
  3. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  4. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  5. Retirement

    Strategies for a Worry-Free Retirement

    Worried about retirement? Here are several strategies to greatly reduce the chance your nest egg will end up depleted.
  6. Professionals

    Your 401(k): How to Handle Market Volatility

    An in-depth look at how manage to 401(k) assets during times of market volatility.
  7. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  8. Retirement

    Maxing Out Your 401(k) Is Profitable: Here's Why

    It's shocking, but most American workers (73%) have no 401(k) retirement funds. Start saving now to anchor your retirement.
  9. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Short Term Hi Yld Bd

    Find out about the SPDR Barclays Short Term High Yield Bond ETF, and explore detailed analysis of the fund that tracks short-term, high-yield corporate bonds.
  10. Mutual Funds & ETFs

    ETF Analysis: SPDR Barclays Short Term Corp Bd

    Learn about the SPDR Barclays Short-Term Corporate Bond ETF, and explore detailed analysis of the exchange-traded fund tracking U.S. short-term corporate bonds.
RELATED TERMS
  1. Security

    A financial instrument that represents an ownership position ...
  2. Series 6

    A securities license entitling the holder to register as a limited ...
  3. Discount Bond

    A bond that is issued for less than its par (or face) value, ...
  4. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  5. Slander

    Slander is the act of harming one person’s reputation by telling ...
  6. Libel

    Libel is publishing a statement about someone in written form ...
RELATED FAQS
  1. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  2. How are non-qualified variable annuities taxed?

    Non-qualified variable annuities are tax-deferred investment vehicles with a unique tax structure. After-tax money is deposited ... Read Full Answer >>
  3. Why are IRA, Roth IRAs and 401(k) contributions limited?

    Contributions to IRA, Roth IRA, 401(k) and other retirement savings plans are limited by the IRS to prevent the very wealthy ... Read Full Answer >>
  4. What are the maximum Social Security disability benefits?

    The maximum Social Security disability benefit amount for a single eligible person in 2015 is $1,165 per month, but you can ... Read Full Answer >>
  5. What are the best ways to use your 401(k) without a penalty?

    The best way to use your 401(k) retirement savings account is to take normal distributions after you reach retirement age. ... Read Full Answer >>
  6. Can I take my 401(k) in a lump sum?

    Establishing a retirement savings plan during your working years is a necessary part of comprehensive financial planning. ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!