There are a lot of annuity salesmen out there that are not going to like what I have to say about these types of annuities. There are many strong arguments (sales pitches) in favor of them. And, I am willing to admit and accept the fact that my opinion is just that, my opinion. I may not have considered certain factors that would enlighten me if I had. However, I have done a fair amount of research into these products from the standpoint of one who could sell them, as well as the standpoint of one who has to answer to his clients at some point down the road. With that said, I am not implying that anyone who puts these products forward to their clients is a scoundrel. I just think that there are a lot of people selling them who have not given enough thought and thorough research time to understanding them and their implications.

Equity Indexed Annuities (EIA)

The concept behind an EIA is that you are guaranteed not to lose any principal while at the same time participating in the gains of the stock market. Good upside potential without any downside risk.

First, an index is a measure of the overall performance of a certain segment of the stock market. The best known indexes are probably the Dow Jones Industrial Average and the S&P 500. If you see what an index is doing (going up or down) you have a pretty good feel for what that segment of the stock market is doing overall.

An EIA will link your investment to the performance of that index. So, if it is linked to the S&P 500 and the S&P goes up 10%, the value of your EIA will also go up, at least a portion of that 10%. However, if the S&P is down the value of your account will not go down. Sounds like a pretty good deal, doesn’t it? Almost too good?

The Benefit

There is the potential to have your investments grow at a greater rate than a fixed annuity or a CD. There is some link to the market in your performance. While gaining some of the potential of the markets, your investments are not at risk of loss.The Down Side –

There are many. First, the “link” to the market is often limited. You may only get 90% of what the index does, or you may get 100% of what the index does up to 10%. If it does better than that, you don’t participate. There are other variations to this, but the point is that you only get part of the up swing – and many times it is extremely difficult for almost anyone to really figure out how much that is. When it comes to these rules, a simple explanation is often way too simple. When I have tried to figure out what the performance of an investment would be with an EIA, using real market returns, I have been less than impressed.

Next, the fees associated with these annuities are often very high compared to other investments. These fees, by definition, will lessen the performance that you could otherwise obtain.

The worst part of these products, in my opinion, comes when you try to get your money out. Life is very unpredictable and people often have a need to draw upon their savings when they hadn’t planned to. I have seen outrageous things written into these contracts. Most have 10 year penalty periods for taking money out. Some are as long as 15 years. On top of that, if you pull your money out during that period you often lose the index linked guarantee. So, not only do you not have the promised growth, but then they take a percentage of the principal as a penalty. If this weren’t bad enough, there are some products that, even after the penalty period, require you to take your money out over five or ten years in order to lock in the promised value. During those five or ten years you only earn a low interest rate like a fixed annuity.

An Insider’s Perspective

Look, a person could make a lot of money selling EIA’s. If that person focused on all of the positives and brushed over the negatives it would be hard to see why a client would want to invest in anything else. On top of that, the commission on these products is often as high as 10%! A salesman can offer a “dream” investment and make 10% commission for doing so. Many do, making a killing in the process. There are actually businesses out there teaching insurance agents how to make a fortune selling EIAs. “Find 20 people in a year with $200,000 each to invest and promise them the moon and you have just made $400,000!”

I will say again that I do not believe that all who sell these things are as bad as I am making them sound. I know several personally who just never looked far enough into the nitty gritty details and honestly thought that these were the best things that they could bring to their clients. The insurance companies are surely not forthcoming with all the negatives when they pitch their products to the salesmen. However, you can also see the great temptation for abuse that others may succumb to. Just be warned.

One Last Thought

From a logical, business standpoint, how can these companies offer these products and promises? Think about it. You give them $100,000 and they immediately pay the salesman $10,000, reducing what they have of your money to $90,000 from the start. Then they have guaranteed that you will never have less than $100,000 and that the full $100,000 will grow as much as the market does, and that the growth will never go down either. That would be a tough thing to make happen. The only way would be to make sure that they have your money for a very long time, charge a lot of fees and penalize you severely if you don’t do everything exactly according to the rules. They better also be sure that in really good years they get to keep some of that growth and limit your participation. I could go on, but you get the point. EIAs simply cannot be all that the are cracked up to be.

Read Part One | Read Part Two

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

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