Equity Indexed Annuity

Equity-indexed annuities are a recent development in the insurance industry, first appearing in the 1990s.  An "EIA" is a form of a fixed annuity contract tied to a stock index that provides the opportunity to earn returns better than those in a traditional fixed annuity, but less than those of a direct investment in the markets.

In this type of contract, the insurance company invests in a mix of bonds and/or stock options designed to give a level of participation on the return of a particular index (e.g., the S&P 500 Index).  Several innovative insurance companies have developed their own indexes which offer greater diversification than a standard index and in some cases more upside.  You have quite a few choices to consider.  In an Equity Index Annuity, if your chosen index falls, then the contract guarantees a minimum return, typically 2%.  Because of that guarantee, the equity-index annuity has less downward volatility than the markets.

There is no free lunch however, an equity-index annuity also limits the maximum returns of a rising market as compensation for that guarantee.  Most equity-index annuities use something called a "participation rate" or "cap rate" to limit returns.  For instance, the insurance company may declare a participation rate of 80% (some companies are as low as 50% so be a good shopper), which means the annuity would be credited with only 80% of the gain experienced by your index for that year.  An insurance company may alternatively declare a cap rate.  These caps are often around 5% to 8% annually, limiting annual returns to those levels.  These limits are necessary in order to offer the safety and guarantees that these annuities offer.

While EIA limits might seem strict to some more aggressive investors, for the conservative investor more interested in not losing, but also unhappy with today's low interest rates, the equity index annuity is a blessing which gives a guaranteed minimum return and a chance to beat today's interest rates by a considerable margin.  For the conservative investor with an intermediate term time horizon to needing income, an Equity Index Annuity may be a very appropriate solution for a portion of a portfolio.

*Again, for longer term money that can be left invested for at least fifteen years, a more direct investment in the markets is often advisable.