Chapter 18. Equity-Indexed Annuities

There Is An old adage about something being too good to be true, but the wisdom of the adage is really a matter of perspective. Certainly, if something appears to be too good to be true, it will be from the buyer's perspective. Only after learning all the realities does the investor experience buyer's remorse.

However, this is not the case for the seller, for whom the transaction was highly rewarding. Such is the case for a product known as an equity-indexed annuity (EIA), a form of a variable annuity. Therefore, much of what is true about variable annuities applies to the EIA world.

An EIA is another one of those products described by the people selling them as providing "the best of both worlds"—the potential rewards of equity investing without the downside risks (because of the guaranteed minimum return). The typical EIA offering has the following characteristics:

  • A link to a portion of the positive changes in an index (typically the S&p 500 Index). This percentage of the index's gain is called the participation rate. Participation rates vary, but are typically between 50 and 100 percent.

  • Principal protection.

  • A minimum rate-of-return guarantee, regardless of the performance of the index.

  • Tax-deferred growth potential.

  • Income options to meet investors' specific needs.

  • A death benefit guaranteeing beneficiaries 100 percent of the annuity's indexed value.

Investors seem to find these characteristics irresistible, purchasing an estimated $25.1 billion ...

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