Equity-Indexed Annuity


With an equity-indexed annuity, you get to participate in the upside when the stock market is climbing, but you also protect yourself against the downside since you'll earn a guaranteed minimum return even if stock prices fall.

In short, an equity-indexed annuity may pay a higher return than a standard fixed annuity would, but have less risk than a variable annuity.


The Basics


An equity-indexed annuity is a special type of fixed annuity, distinct enough to be accorded its own category. An indexed annuity provides you with exposure to one of the stock indices, such as the S&P 500, while guaranteeing the return of your principal investment. They provide you with the opportunity to capture a portion of the growth of the stock market while keeping one foot on dry land. These vehicles can effectively provide superior rates of return and still allow conservative investors to sleep peacefully at night.


If you want to reap some of the benefits of market returns, but don't want to take on all of the risk and volatility of the stock market, you might want to consider an equity-indexed annuity.


Equity-indexed annuity contracts function much like their fixed counterparts in many respects. They have set maturities ranging from one to ten or fifteen years, a declining surrender charge schedule and tax-deferred growth. They also provide the same exemptions from probate and creditors.


But unlike regular fixed annuities, most equity-indexed contracts do not pay a set rate of interest. Instead, you’ll receive some portion of any growth posted by the benchmark stock index upon which the contract is based. The percentage of participation typically ranges anywhere from 60-90%, depending on various factors. For example, if you purchase an S&P 500 contract and this index rises by 20% over the seven-year term of the contract, you would realize perhaps three-quarters of that growth — without risking the principal.


Equity-indexed annuity contracts are taxed in the same fashion as any other type of annuity. All money inside these vehicles grows tax-deferred until you take distributions.


What Are Some of the Contract Features?

Two features that have the greatest effect on the amount of additional interest that may be credited to an equity-indexed annuity are the indexing method and the participation rate. It is important to understand the features and how they work together.


Other equity-indexed annuity features that affect the index-linked formula are:

  • Indexing Method - The indexing method means the approach used to measure the amount of change, if any, in the index.

  • Term - The index term is the period over which index-linked interest is calculated.

  • Participation Rate - The participation rate decides how much of the increase in the index will be used to calculate index-linked interest.

  • Cap Rate or Cap - Some annuities may put an upper limit, or cap, on the index-linked interest rate. Not all annuities have a cap rate.

  • Floor on Equity Index-Linked Interest - The floor is the minimum index-linked interest rate you will earn.

  • Averaging - In some annuities, the average of an index's value is used rather than the actual value of the index on a specified date.

  • Interest Compounding - The interest earned in one term is usually compounded in the next.

  • Margin/Spread/Administrative Fee - In some annuities, the index-linked interest rate is computed by subtracting a specific percentage from any calculated change in the index.

  • Vesting - Some annuities credit none of the index-linked interest or only part of it, if you take out all your money before the end of the term. The percentage that is vested, or credited, generally increases as the term comes closer to its end and is always 100% at the end of the term.




The questions listed below may help you decide if an equity-index annuity meets your retirement planning and financial needs. You should consider what your goals are for the money you may put into the annuity. You need to think about how much risk you're willing to take with the money.


Ask yourself:

  • How long can I leave my money in the annuity?

  • What do I expect to use the money for in the future?

  • Is a guaranteed interest rate more important to me, with little or no risk of losing the principal?


Equity-indexed annuities can provide valuable market exposure for conservative investors. Those who can benefit from these products should be certain that they thoroughly understand all of the rules and restrictions in the contract. But make sure you read through the terms carefully and consider all of the fees involved before you buy.


"Securing Your Financial Future"