In basic terms, and annuity is an amount of money that is earned as a return on investment, which is paid on a predefined schedule (i.e. – quarterly, biannually, or annually). Annuities are usually used as a critical component of a retirement plan, because they ensure a fixed, stable income upon retirement. One particular type of annuity that has become increasingly popular is the equity-indexed annuity, which is basically an annuity that earns interest and is directly linked to a stock or other type of equity index. Thus, equity-indexed annuities allow the annuitant to indirectly invest in the stock market on an ongoing basis by attaching their annuity returns to additional investment. However, it is important to note that the annuity is not directly invested into the stock market, but is rather contributed towards a fund that is utilized by an experienced investor, who then offers the annuitant a specific percentage of the total returns gained by the index over a set period of time. The following paragraphs discuss the unique attributes of equity-indexed annuities, their benefits, and how to choose an annuity based on a variety of factors.
What Makes Equity-Indexed Annuities Different?
The primary difference between an equity-indexed annuity and conventional annuities is the method used to credit interest towards the annuity's value. While the majority of fixed annuities credit interest to the account based on a set rate specified in the annuity contract, equity-indexed annuities utilize a formula that is based on fluctuations of the index that the annuity is attached to. Thus, the total amount of interest earned can vary greatly and will depend entirely on the features and interest formula of your annuity contract. However, while the return may be inconsistent and unpredictable, equity-indexed annuities are similar to other fixed annuities in that they do provide a minimum guaranteed return, regardless of whether the linked index (investment) gains or loses value. For example, the majority of premium annuity contracts include clauses that guarantee a minimum value which will never be less than 90% of the premium paid by the annuitant. Since the value of the annuity depends on the value of the index, total returns are populated and adjusted at the end of each term, thereby reflecting index increases.
What Are the Benefits of Equity-Indexed Annuities?
Unfortunately, since annuities usually utilize a predefined combination of indexing features, it is likely that regardless of which annuity you choose, there will be some unappealing features within the contract. Although equity-indexed annuities do not provide guaranteed returns or set rates, they can offer some of the most advantageous returns if the attached index does well. Thus, there are two main benefits of equity-indexed annuities – a higher average rate of return than fixed income assets (i.e. – bonds or cash deposits), and a significant reduction in risk. In essence, equity-indexed annuities provide all of the benefits of investing in the stock market, without the risk of taking a loss. Since annuity providers guarantee a minimum return, it is essentially the same as gathering the annual profits of stock investments, without the usual losses associated with such endeavors.
How to Compare Equity-Indexed Annuities
As with every other type of insurance policy, it is important to carefully review and consider all options before choosing an equity-indexed annuity. Keep in mind that it is very unlikely that you will find annuity design with all of the features you desire, so you may need to weigh the pros and cons of multiple equity-indexed annuities before selecting a contract that is most suitable for your needs. Since there is such an abundance of equity-indexed annuities available, it may be more ideal to establish a predefined set of criteria before comparing multiple options, rather than vice versa.