Pros & Cons of an Equity-Indexed Annuity

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An equity-index annuity is influenced by the rise and fall of the stock market.
An equity-index annuity is influenced by the rise and fall of the stock market. (Image: Stock Market image by Paul Heasman from Fotolia.com)

There are a few reasons why an equity-index annuity is attractive. Let's say you can't choose between a variable annuity or a fixed annuity. An equity-indexed annuity offers the investor the best of both worlds. An equity-indexed annuity is also an option if you want to benefit from market returns but don't want to handle the risk of the stock market. Before purchasing an equity-index annuity, consider the pros and cons.

Definition

The Securities and Exchange Commission describes an equity-indexed annuity as a special type of annuity. During the accumulation period, the insurance company credits the investor with a return based on the changes in an equity index, such as the Standard & Poor's 500. The accumulation period is when the investor makes a lump-sum payment or a series of payments. The insurance company guarantees a minimum return. Guaranteed minimum return rates vary. After the accumulation period, the insurance company makes periodic payments to the investor under the terms of the contract, unless the investor chooses to accept the contract value in a lump sum.

Function

An equity-indexed annuity is a combination of a variable and fixed annuity, according to CNNMoney.com. Like a fixed annuity, the investor gets a low-risk guaranteed minimum returns that typically runs between 2 to 3 percent. Similar to a variable annuity, the investor has an opportunity for potential higher gains if the stock market rises, since an equity-indexed annuity's return depends on the performance of a benchmark index, like the Standard & Poor's 500.

Pros

With an equity-indexed annuity, the investor benefits when the stock market rises, according to CNNMoney.com. The investor is protected from when the stocks tumble since the investor will receive a guaranteed minimum return. An equity-indexed annuity may provide a higher return than a fixed annuity. An equity-annuity is considered lower risk than a variable annuity.

Cons

CNNMoney.com reveals that equity-indexed annuities are complex investment tools that come in various forms. Because they are so complicated, they are extremely difficult for investors to fully understand. Equity-indexed annuities do not always match the index's full return because they calculate gains in many different ways. There are fees, such as surrender charges that can last for 15 or more years and can run as high as 20 percent.

Expert Insight

According to CNNMoney.com, when buying an equity-indexed annuity, read the terms carefully and research all the fees involved before purchase. The Financial Industry Regulatory Authority has compiled a useful investor alert on annuities (see Resources).

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