The Equity-Indexed Annuity

The second issue is the overall cost of these accounts. Annually, there is a fee charged against the value of the account of between 2% and 3% annually.  Doesn’t seem like much, until you think back to the caps that are placed on your account’s participation in the market.  Suddenly, that 8% cap becomes 5% when you remove the annual fees.  And what about if the market just goes sideways?  You still lose 3% to fees every year.

The third issue is the annuity term. As with all annuities, there is a term during which you are not free to withdraw the balance without penalty. The penalty varies but can be steep, as much as 20% depending on the contract. This can cause a liquidity problem – if you need money right away, you might not have ready access to it without paying the penalty.

I just thought I’d give you a brief rundown on these accounts since they’re getting a lot of “push” these days – since the market decline has highlighted their selling points, plus there is a lot of upside potential benefit to the companies pushing them.

There’s a reason equity-indexed annuities are popular: market drops are scary. And sometimes we’ll overlook the downsides to get some protection against scary things.

There’s also a reason equity-indexed annuities are popular with insurance companies: historically, the market returns negative overall results one out of every four years. Plus, the average annualized return of the S&P 500 over the past 50 years has been approximately 11%. So the insurance company has to pay the guarantee only 25% of the time, and the rest of the time (on average) they are able to glean 3% off the top of the contract.

Finally, equity-indexed annuity is one of the only types of investment that FINRA has seen fit to produce an investor alert about. It’s important to have your eyes wide open if you’re considering one of these contracts.

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