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Mortgage Information
Equity Indexed Annuities
by
Sukhdev Singh
800-242-0919 X 285
ssingh@coastcities.net
Share in market gains without the risk?
In the past, investors saving for retirement by investing in the U.S. stock market have had to endure market volatility and the risk of losing their principal in exchange for possible future growth. But what if it were possible to participate in the "growth of the market" but completely elminate the volatility and risk associated with being "in the market". The answer for many investors may be a relatively new type of tax-deferred annuity available today known as an Equity Index Annuity or (EIA).
EIA's are fast becoming a popular choice for investors seeking to eliminate 100% of the risk of losing money but still want to benefit from a potentially rising stock market. How does an EIA actually work? First, you need to understand that these are fixed annuities, either immediate or deferred, that earn interest and provide benefits that are "linked" to an equity index. The value of an equity index is simply based upon what the index is made of. Probably the most commonly used equity index familiar to most of us is the Standard & Poor's 500 Index (the S&P 500). Therefore, when investing in an EIA, it's very important to know what index your annuity is actually "linked" to.
So let's assume you deposited $100,000 into an EIA that is "linked" to the performance of the S&P 500. You would now earn interest monthly or annually based upon the rise of the S&P 500 Index. At the end of the first year, if the S&P 500 Index had risen 12%, your account would be credited with 12% of interest and the annuity value would be worth $112,000. However, if the market had fallen at the end of the first year, (here's where 100% of your principal risk is elminated) you would not loose money because EIA's have floors that won't allow you to go below 0% even if the S&P 500 Index had fallen that year. In addition, many insurance companies who offer EIA's also provide a minimum guarantee of 3%. Think of it as an elevator that will never go into the basement (below 0%) and allows you to at least get to the third floor (a 3% minimum guarantee).
So what's the catch? Well, since the insurance company is guaranteeing that you won't go into the basement the only limitation is that you must give up some return in exchange for the safey of your principal. For example, the S&P 500 index returned 26% last year. For those investors who bought EIA's at the beginning of 2003 and then looked at their statement at year-end, their gains may have been limited to 12%. That's because EIA's typically have a "cap" on the amount of interest you can earn each year based on the performance of the index it's measuring.
So why should you be happy with 12% versus 26%? For one, if you had invested in the same EIA only one year earlier the market actually lost 23% but because you bought an EIA you would have had an absolute zero% loss! I know plenty of people that would be more than happy to settle for a 12% "cap" on their gain each year in exchange for never losing any of their principal when the market goes down.
Secondly, if you look at the historical performance of large company stocks since 1926, the average annual return has been about 11%. So, over time the those gains you think you may be missing out on when the market rises above 12% won't be missed because the market will look more like it's long-term average the longer you own your annuity.
In closing, it's important to understand that your principal guarantee in an EIA is always based upon the insurance companies ability to pay just as with any fixed annuity you may have purchased in the past. So be sure to seek out insurance companies with superior financial strength and those that have the highest available ratings from agencies like Standard & Poor and A.M Best. It's also a good idea to select an advisor or agent who truly understands EIA's to explain the different choices available and most importantly to see if an EIA is right for your personal or retirement account.
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