The Equity-Indexed Annuity

If you’re anywhere near retirement age, or if you’re in retirement, chances are that barely a week goes by without having an Equity-Indexed Annuity (EIA) pitched to you these days…

Now, if for some reason you’ve missed out on these pitches (Maybe you’ve been out 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 salesguy 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 40% plus drop, there is high potential for double-digit increases in the coming months and years.  If there is a cap on your upside “participation” of say, 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 had for the past several months.  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.

And so – the downside protection that you receive comes at the cost of limited upside, which would have throttled 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…

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%.  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.

There are many other “gotchas” to consider with regard to EIAs.  Both the SEC and FINRA have issued alerts about these products. (click the links to go to the alerts)

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.  Now, it’s possible to set up your IRA to do something similar to the EIA – here’s an article which goes into the details if you’re interested.

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Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 20 years of experience in the industry.  . Read more from this author