Here’s a proposition: Fearful investors provide a ready market for products that sound safe, but aren’t. Exhibit A in support of that proposition? The Equity Indexed Annuity, or EIA.
An EIA is an annuity, meaning it’s a contract to pay a guaranteed minimum interest rate, which is then goosed up by aligning the rate it pays to a stock market index like the S&P 500. If that index goes up, the annuity increases by part (not all) of the gain. On the other hand, if the index goes down the annuity does not decrease in value. Investors who were rattled by recent stock market declines bought over $30 billion in EIAs in 2009 alone.
So what’s not to like? Well, let’s start with the fact that EIAs are full of “gotchas.” For example, gains in the stock index do not equate to equal gains in the EIA’s return. Generally, the EIA investor only gets a percentage of stock market gain. Many EIAs put a cap (often 4.5%) on market gains. Likewise, if you invest in the S&P 500, your return includes dividends paid by the stocks in the index. Most EIAs don’t include dividends.
The expenses charged by EIAs are also return killers. These expenses, which reduce yield, are hidden from plain view. Virtually all EIAs include substantial surrender fees, which can be up to 15% of the purchase price and only phase out after many years. Imagine having to pay to get out of an investment that you’re unhappy with!
It’s very easy to understand why brokers and insurance agents love to sell EIAs. Commissions are often ten percent or higher which is, in a word, obscene. Do your wallet a favor and avoid EIAs. However, if you already bought one and weren’t told the whole story, consider consulting counsel to see if you can get out and recoup your losses.