The Equity-Indexed Annuity

If you’re anywhere near retirement age, or if you’re in retirement, chances are you’ve had an Equity-Indexed Annuity (EIA) pitched to you.

Now, if for some reason you’ve missed out on these pitches (Maybe you’ve been out of the country? Don’t have a phone? Don’t read your mail?) here’s the gist:  Insurance salesman tells you about this wonderful product that allows you to participate in the stock market’s upside, while not experiencing any of the market downside. In today’s stock market climate, sounds pretty good, huh?

A couple of things come into play that the sales guy doesn’t highlight for you:

First, your “participation” in market upside is limited. Typically there is a cap on the amount of market upside that the account will pay out, and in this market climate, the upside potential is tremendous, which will primarily benefit the insurance company, not you.  In other words, given that the market has experienced a significant drop, there is high potential for significant increases in the coming months and years.  If there is a cap on your upside “participation” of say, 6% or 8%, the rest of the account’s upswing goes to the insurance company’s bottom line.

Now, you might say – that’s a small price to pay for not having to endure a downswing in the market like we have experienced recently.  And I would agree with you on that score. However: this is a hindsight statement because again, the chance is quite small that the market will continue trending continually lower after its performance of late. There often are minimum guaranteed rates of return that can help on the downside as well, but the end result can be that you get back less from the contract than you originally deposited.

And so – the downside protection that you receive comes at the cost of limited upside. The limited upside throttles back your performance in the bull market periods, leaving you with dismal returns overall.  But that’s not the biggest issue you face with these accounts…

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