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Dan Otter

What Are Equity Index Annuities?

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The following post on equity indexed annuities appeared on our old 403(b)/457 message board recently. It generated some terrfic discussion so we thought it might make sense to repost here and continue the debate.



Initial topic post by Ed...


"Hello all. My prayers are with those who are fighting overseas. I joined a friend breifly after school today to listen to a "financial advisor". He touted something called an index annuity. I asked what the cost was and he said there was none. This sounded fishy to me. He said there was a surrender fee that reduced to 0 after 10 years. He said he was paid by the company not by a teacher's contributions. I did not argue with him but I understand that the company pays him from a cut of the teacher's contributions.


What about these index annuities? He says the principal never goes below the amount contributed and from there it can go up. It, as always, "sounded" like a good deal. If anyone has good understanding of index annuities, I would appreciate hearing from you.


First response by Alec...


Hey Ed,


Here are some links to explain more about Equity Index Annuities (EIA):










This is what I got from some quick reading. “Equity-indexed annuities are not currently regulated by the federal Securities and Exchange Commission” like mutual funds and most variable annuities. Hence, the sellers of EIA’s don’t have to be licensed and don’t have to disclose everything in a prospectus. Heck, they don’t even need a prospectus.


Also, unlike investing in stocks through VA’s or Mutual funds, the money you give the insurance company is not directly invested in the stock market. You don’t get any dividend yield or dividend growth. You only get capital appreciation (increases in stock prices). And you only get a % (specified in the EIA contract) of this capital appreciation. Could be 100%, could be 50%. Hmmm… no dividend yield or dividend growth – doesn’t look so good for the long-term investor does it if you can’t reinvest dividends? Don’t dividends and dividend growth account for the majority of long-term stock returns?


I’m sure the seller of an EIA will show you a graph of how much you would’ve made if you’d invested from 1980-2000. And this predicts the future price increases of the stock market how? Whenever someone shows me a graph like this, I always think of Disco Stu, from “The Simpsons”, showing Marge a graph of sales of Disco related products ending in 1978 or 1979, and then saying “If these trends continue, Heeeyyy…” We all know what happened to Disco.


You might ask this “financial advisor” (or your fellow teachers) if he gets more money for signing more people up for this EIA, how can you possibly believe him when he says that this is a good investment? Isn’t his salary directly affected by how many people he signs up? Did he say that this is a good investment for everybody? Is anything a good investment for every single person? How can he possibly know this? If this was such a superior investment (meaning you wouldn’t ever want to withdraw your money), why does there need to be a surrender charge? Does this guy have any certifications (CFA, CFP) or even a degree in a finance related field that would make his recommendations believable?




Second response was by ScottyD:


One word - commmissions! I believe the majority of these products are sold because of the high commission associated with them - typically 10 - 15%. This is not always the case, but in my experience in the teachers market it has been. I am not a fan of these products because of the long surrender periods and the fact that most agents flat out lie to sell them. Whatever you do, do not confuse them with an equity investment, they are not, and they should not be compared to an equity investment - they are a form of a fixed annuity.




Third response was by Chuck:


I agree with Scotty: an Index Annuity should be compared to a fixed annuity (which, technically, it is, which is why it is not regulated by the SEC and does not require a prospectus).


The idea behind the Index Annuity is a good one: rather than lock people into a fixed annuity, which reflects current market conditions and expectations but which may not continue to do so indefinitely, use a fixed, guaranteed base for the annuity, but also let the owner share in the market upside.


Obviously, you cannot share fully in the upside if you are guaranteed not to share in the downside. Also, rather obviously, this kind of arrangement is complex to develop, sell, and administer, so expenses tend to be higher than for plain vanilla annuities. These issues may well be valid reasons, in any given case, for avoiding the product.


There are so many variations on index annuities out there, that it is very hard to generalize. I do think it is fair to say, though, that in ALL cases you need to be willing to invest some serious time to read and understand the product specifications fully (if you do not get written product specs, walk away!). You really need to be something of a financial genius to intelligently compare two such products, unfortunately, so it is difficult to know whether you are getting a good deal.


Personally, I would not dismiss this concept out of hand, IF you are the kind of person who likes the idea of a fixed annuity, but wants a chance at some upside participation. The market is well off its peak right now, and over the long haul there is probably a lot to gain on the up side. If you want a piece of that action, but feel you cannot afford (or would not sleep well) taking downside risk, an index annuity could be the right thing for you.


But if so, be careful. When you look at all the costs and at the limitations on the gains, you might change your mind!


Ed posted the last response:


I was skeptical of this product when I heard about it. It sounds good-no negatives and rises as market rises. My increasing understanding is that the fees are killers for retirement accounts. Thanks for the input on the index annuity. For now, I think I will keep my 403b with Vanguard and Fidelity.


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