An equity indexed annuity is quite similar to a variable annuity in that it relies on a base constructed of financial assets. The assets that comprise the equity indexed annuity are always a market index and never individual funds like a variable annuity is made up of. If you want to take part in the profits of the stock market, but want to play it as safe as possible, this type of annuity will serve you best.
The most commonly mirrored index is the S&P 500. Remember, you are not actually buying shares of this index; the annuity is simply using this index in order to give you a reference point for your investment. The annuity might not change in price as an exact mirror image of the index, but it will be very closely related.
The person that benefits the most from an equity indexed annuity is the person trying to protect their savings from the whims of the economy. Inflation has historically risen by about 3 percent per year since the Great Depression. This type of annuity will grow at about the same rate. There is no guarantee that the annuity will be changing at exactly this rate, but equity indexed annuities have historically performed at about the same level as the overall economic growth.
Equity indexed annuities only grow as much as the connected index grows. Indices usually rise in price at roughly the same rate as inflation. This means that if you are looking for an investment that will outpace inflation, an equity indexed annuity is not for you. Inflation is generally around 3 percent per year, so you can expect your annuity to grow at about this pace for the long haul. There is always the potential that your annuity will go up or down from this 3 percent, but if you are looking at the long term, this is about what you should plan for.
Is an equity indexed annuity for me?
Are you looking for a way to keep your savings at a steady value while still enjoying the benefits of the stock market? Equity indexed annuities are a good tool when it comes to battling inflation. Your money will grow in price in relation to the major index you select, thus insuring that your money does not lose relative value. Some years it will grow more than others, but you can expect your savings to grow at about the same rate as inflation. While CDs or fixed annuities cannot do this year after year, an equity indexed annuity can. The downfall here is that there is no guarantee that the stock market will go up every year, thus making equity indexed annuities a bit riskier over the short term than these other investments.
Other things to consider
Not all equity indexed annuities are created equal. Some have lower participation rates than others. This means that during years that the market performs exceptionally well, you will not see the same growth as the attached index. A common participation rate is 50 percent—you will see a rise in your annuities value at half the rate as the increase. This is actually meant to protect you over the long run. Rather than losing money in down years, you will be protected if your annuity has a minimum growth rate attached to it. If you are risk adverse, the participation rate will actually help you during bad economic years since there is always left over cash during the best years of your annuities life.
If you are looking to get the safest equity indexed annuity for your value, go with the one that has a guaranteed minimum rate of return. This will make sure that you are getting a return on your investment even when the stock market goes down. The participation rate for these annuities will be lower, but you will always have something to show for your investment.
Equity indexed annuities offer a bit from both fixed annuities and variable annuities. They are connected to a variable market, like the variable annuity, but they also sometimes have a minimum guaranteed rate in order to provide during the years that the stock market does not increase. If you are looking for a safer alternative to the variable annuity, but still want to take on a degree of risk, this type of annuity is perfect for you.