Equity-index annuities (EIAs) are gaining popularity. An EIA is linked to a stock market index, such as the S&P 500. Investors get a guaranteed return, tax-deferred, as they would from a traditional fixed annuity, but that return might go even higher if the relevant stock index performs well.
If you are interested in an EIA, review these aspects:
- Participation rate. This varies from one contract to another. If the participation rate is 60 percent, for example, and the underlying index goes up 10 percent, not counting dividends, your contract value would increase by 6 percent: 70 percent of 10 percent.
- Caps on gains. Suppose the underlying index goes up 30 percent and your participation rate is 60 percent, as above. If the contract has a 10 percent cap, you would get a 10 percent increase, not 18 percent.
- Guaranteed minimum return. Typically, EIAs promise at least a 2 percent or 3 percent annual return. This comes into play at the end of the term of the contract.
Suppose, for example, a contract has an annualized 3 percent minimum return and a seven-year term. At the end of seven years, the contract value would be whichever is greater, the guaranteed return or the overall equity-linked return.
