Equity-Indexed Annuity Explained – Interest Rates, Caps, Yields and Yields – How Does It Work?

Investors seem to be looking for safety now more than ever, especially after the major stock market correction of 1999-2002. Four years later, numerous brokerage and variable annuity accounts have still not recouped their losses from that period. Unfortunately, many investors have relied on these funds to generate income during their retirement.

Hence the introduction of the Equity Indexed Annuity, or EIA, into the mainstream marketplace. Equity-indexed annuity is designed to provide a higher return than traditional fixed annuity and can be a reliable alternative to a brokerage account. Only 15 years old, several billion dollars were deposited into these accounts.

pensions in general

First, a potential investor should have some background information. In general, an annuity works as follows: the investor, usually referred to as the owner or annuitant, agrees to deposit funds with an insurance company for a specified period of time, say 7 years. The pension is to be deferred during this period. During deferral, most annuities allow for a partial payout of interest earnings, or a 10% annual free payout, or the minimum payout required by the IRS (Many annuities allow larger payouts if the owner is placed in a nursing home or is terminally ill.) Another way to earn retirement dollars Distribute is a systematic withdrawal called an annuity payment based on a predetermined schedule, say 5 years. However, if the consumer chooses to take out the entire contract in one lump sum before the annuity is due, penalties will apply based on the repayment schedule in the annuity contract. If the investor dies, the lump sum annuity will be paid to a beneficiary on death unless other arrangements have been made.

Technically, stock-indexed annuities are called fixed annuities by the various insurance departments in each state. That is, at no time does the investor own any variable type of security such as stocks, bonds, or mutual funds within the EIA account. These accounts do not fluctuate in value like a variable annuity. But the stock-indexed annuity isn’t like a typical fixed annuity, either.

The stock-indexed pension benefit

What sets RRPs apart from a traditional fixed annuity is how the interest is credited to the account. Typically, the insurance company will buy an option on a specific index, such as the DOW, S&P 500, or the NASDAQ. After a certain period of time, usually one year, the option contract becomes due. One of two things will then happen. If the market index has risen, the option is exercised and the interest is credited to the annuity capital. Conversely, if the market has retreated, the option expires and no interest is credited to the account for that year.

In practice, the annuity gains or keeps its value every year, but the investment cannot lose value due to negative market fluctuations. (It’s also important to note that all EIAs have a minimum guarantee of their returns. For example, this guarantee could mean that if the market declines each year during the life of the annuity, the insurance company will continue to guarantee payment of 88% of those paid in Premium (However, this safety feature is not widely used.) Investors should also know that most stock-indexed annuities have a fixed-rate account as an additional investment opportunity When interest rates are high and the stock market is down, the fixed-rate account can be used to earn interest on the annuity principal to credit.

Stock index performance

How are these annuities developing? Historically, many of these accounts have averaged returns of 7% or more. In years when the broader markets have performed well, so have EIAs. It’s not uncommon for investors to enjoy interest payments of 10-20% or more during these prosperous years. However, the critical value of these accounts is realized during rapid market declines when the stock-indexed annuity retains its capital and interest gains from years past.

These facts may explain the recent popularity of EIAs, particularly among retirees who want to preserve the value of their hard work in life. With the market growing and falling so quickly, many consumers are looking for security without sacrificing decent interest income. Granted, these annuities won’t return 50% a year like a lucky stock or fund pick might, but knowing that investors know their investment can’t dwindle is prompting many to put some of their retirement savings into these accounts .