Understanding an investment and its costs can protect you from making an unsuitable choice. An equity-indexed annuities are a complex investment that retirees should thoroughly understand before they buy. The Security & Exchange Commission (SEC) says the public – especially seniors – require more awareness about how equity indexed annuities really work and the costs they carry.
Equity indexed annuities may be viewed as a hybrid of a fixed annuity - which pays a fixed rate - and a variable annuity, whose return depends on the performance of market securities. Equity indexed annuities guarantee the investor's principal and a minimum return, but may pay more based on the performance of the underlying securities that make up a particular market index such as the S&P 500.
But equity indexed annuities can be confusing. One confusing feature is how they calculate the benefit (credited interest to the equity indexed annuities) from an increase in its associated index. Different equity indexed annuities use different indexing methods. This variety and their complexity make it difficult to compare one equity indexed annuity to another.
Significant growth in equity indexed annuities in recent years has also brought complaints too. The SEC says these arise from the equity indexed annuities often complex features not adequately disclosed, that commissions on the products are out-sized, and that some carry high surrender charges imposed over long periods, which can make them particularly unsuitable for seniors and others who may need their money right away.
Up 'til now equity indexed annuities have been considered insurance products - restricted to purely state insurance regulations. But the SEC wants to regulate equity indexed annuities. It proposes a rule that would define equity indexed annuities as a security and thereby place them under the supervision of the Financial Industry Regulatory Authority (FINRA), a non-government regulator of U.S. securities firms. The insurance industry was able to defeat the proposal – for now.
Now, those with insurance licenses can sell equity indexed annuities. But if the SEC proposal ever goes through, one will also need a securities license, much harder to obtain, to sell equity indexed annuities.
But whatever the eventual outcome, investors hopefully will win when pressure increases to give them the full disclosure – and understanding - they must have on the actual benefit and costs that an equity indexed annuities presents. In any case, before you buy an equity indexed annuity, be sure you understand all its features and be prepared to ask us whether an equity indexed annuity is right for you.
This author thinks that equity indexed annuities are fine investments and offers these tips:
- only invest in the contract that has a fixed participation rate for the term of the contract
- don't invest in any contract that has caps
- try and get a contract with the annual reset feature
- try and avoid any type of averaging of the index in the interest crediting calculation