An equity-indexed annuity is a combination of a fixed and a variable annuity. The marketing pitch usually goes something like this: Equity-indexed annuities give you the best of both worlds: the guaranteed return of a fixed annuity, with some potential for upside. The equity-indexed annuity’s return is also tied to the performance of a benchmark index, such as the Standard & Poor’s 500.
Does this sound too good to be true? As you can guess, there’s good reason to be cautious. The reality is that equity-indexed annuities are very complicated investment vehicles, and they come in a wide variety of forms. Their complexity makes them extremely difficult for investors to understand, and marketing pitches can often be deceiving.
For one, they don’t necessarily give you the entire return of the market index they’re tied to. Different equity-indexed annuities calculate your gains in different ways. For example, some give you only a portion of the index’s overall return, or set an annual cap – and most exclude dividends. So if the market returns are a big draw for you, make sure you know exactly what you’re getting.
And then there are fees. In some indexed annuities, surrender charges can run as high as 20% and last for 15 or more years. So you may not have access to all of your money without paying steep penalty charges for a long, long time.
The Financial Industry Regulatory Authority (FINRA) has issued a useful investor alert on how to size-up equity-indexed annuities.