Equity-Indexed Fixed Annuities

Talk about a tongue-twister! Bet you can’t say that three times fast!  Equity-Indexeded… Equity – Indexed Fixed Anninuii…we give up!


Don’t let the long title fool you or turn you away.  An Annuity can be a great tool in your retirement years.  Simply speaking it is income that won’t run out.  The principal money in an equity indexed product has guarantees in place that protect it which isn’t always true in a mutual fund.  Another benefit is it’s credited based off of an index, allowing you to participate in higher interest rates on years of favorable market returns than a traditional fixed product. 


With all the moving parts they can be complicated to understand.  Let’s break it down so you can know if it is the right product to meet your financial goals.

What is an annuity?

First let’s define what an Annuity is.  An Annuity is a contract between a client and the insurance company to provide steady income payments for a lifetime, or a specified period of time. Usually they are used in retirement to prevent outliving savings.  This is probably the biggest concern many have for themselves or someone they care about. 


Some of the benefits of an annuity are tax deferred growth, principal preservation, lifetime income, or leaving money to a beneficiary. Depending on what your needs are they can be the best financial tool for the job over other investment options.  Please note, an annuity is intended to be a long-term financial tool and is not a short-term investment strategy.  There are often heavy surrender charges for pulling out money early, so even in light of the benefits these restrictions can make them less liquid than many other  investment tools.   


Annuities can be set to pay for a lifetime or for a specific period of time, for example 20 years.  They can be immediate, beginning to pay out right away, or deferred, which will set up the payments for a later date, and can be fixed, with a guaranteed interest rate locked in, or variable, with money invested in securities. An Equity Indexed Fixed Annuity is kind of a hybrid between fixed and variable. It is considered fixed in how it is regulated since there are safeguards to not lose your investment, but will be credited based off of the performance of a specific Index, such as the S&P 500.

How an Equity-Indexed Annuity works

An Equity Indexed Fixed Annuity will have an interest credit floor, or a minimum, often 0%. This means that in a down market year you will not lose your principal investment, however, in an up year your return may be capped or only a percentage of the full gain is credited. A traditional fixed annuity will have a higher guarantee, but you will not have the potential for higher returns as well.


You may ask how can you participate in years of positive growth and not have the risk when the market goes down. Let’s use a different analogy to understand it better, such as the housing market. If instead of buying a home for $100,000 you set up a contract that will allow you to buy the home within a set amount of time if you would like. Let’s say you pay $1,000 for this option to buy. If after the length of the contract timeframe you feel the home has increased in value or held its value to your satisfaction you can then pay the $100,000 to buy the home. Since you had to pay a fee in order to buy the home later, you have invested more than the original value, hence the cap in an indexing strategy. If you decline the offer because the value of the home has gone down or not gone up what you wanted, you do not have to participate in the purchase and you are only out the fee that you had for the option to buy. With this second scenario, if the money that you didn’t spend on the home was in an account making a small amount of interest, roughly 1%, then the $99,000 has now become about $100,000 again, hence the 0% floor in an equity indexing strategy.


Each company that offers equity index annuities will have different crediting strategies and index options. It is important to review the history of the index and how the interest will be credited. Often illustrations will show you how past years would have performed if the contract was in place, and although it cannot be guaranteed how the indexes will perform in future years it can help to understand how they work and what the risks are. For example, a one-year point to point strategy with an 80% participation rate that is tracking the S&P 500 would look at the change in the index after one year. If one year from the start date the S&P 500 index has gone up 22% you would be credited 80% of 22% or 17.6%. If one year from the start date the S&P 500 has gone down 3% the floor rate would kick in and you would be credited 0%. This is what allows the product to be considered fixed, without the risk of losing your original investment.


Key Takeaways

There are pros and cons to each investment tool. Looking at what is most important to you to accomplish your primary objective can help decide if an Equity Indexed Fixed Annuity is the right tool for your situation. Benefits of this product are principal protection with growth potential and income that you can’t outlive. The negatives associated with this option are that it is less liquid, with surrender periods locking up some or all of the funds for a period of time.


Make sure to reach out to us if you would like illustrations run or additional information on Annuity products available.


Contact Us

P.O. Box 249
123 N. Main St.
Crosby, ND 58730