Equity-Indexed Annuities
The equity-indexed annuity (EIA) is a type of fixed annuity that tracks the performance of an index. An index is a statistical measurement used to measure the performance of a market. Indexes may measure either stock or bond markets, or different sections of the market. Someone who invests in an EIA receives a return that is directly related to the performance of a particular index.
The upside return of an equity-indexed annuity is limited in a couple of ways. One of these is the participation rate, which is the rate at which the annuitant can participate in the returns of the index. For example, when an annuity has a participation rate of 80%, the investor will benefit to a maximum of 80% of the increase in the annuity’s index. If the index goes up 10%, the investor would receive 80% of 10%, or 8% (0.1 x 0.80 = 0.08).
Equity-indexed annuities also may be subject to caps on performance. If an EIA has a cap, the annuitant will not receive a return higher than the cap, even if the increase in the index return times the participation rate is higher than the cap. For example, suppose an EIA has a 90% participation rate with a 12% cap. At the end of the year, the benchmark index has increased by 20%. Without the cap, the investor would receive 90% of 20% or an 18% increase in rate of return (0.9 x 0.2 = 0.18). With the cap, however, the investor would receive a 12% increase.
Some EIAs use a spread, margin, or asset fee in addition to or instead of a participation rate. The percentage stated in the contract is subtracted from any gain in the index linked to the annuity. For example, if the index gained 10% and the spread, margin, or asset fee is 3.5%, then the gain in the annuity would be only 6.5%.
EIAs often come with a rider that offers a 1% to 3% guaranteed minimum return. This usually means that the EIA protects against downside risk. For example, imagine that an investor invested $100,000 into an EI