Equity-indexed annuities
If your money is invested in an EIA, it can be locked up and inaccessible to you for many years, with early withdrawal penalties topping 10 percent.
Some annuities, such as fixed annuities, can serve you well, delivering needed income in retirement. Others, though, such as equity-indexed annuities (EIAs) (sometimes called “fixed-indexed insurance products”), are extra-complicated — and problematic.
Both the Financial Industry Regulatory Authority and the Securities and Exchange Commission have issued advisories about EIAs due to high hidden fees and other problems.
Salespeople can earn commissions of 6 percent or more selling you indexed annuities. The sales pitch will often sound too good to be true: You may be told you can get the return of the stock market index without the risk of loss. Usually, there is a “guaranteed” rate of return.
Your yield is typically based on an index, usually the S&P 500. But there is a “participation rate” that will lower your gain.
For example, if your participation rate is 80 percent and the index returns 10 percent, your gain is only 8 percent (80 percent of 10 percent).
There are also caps that limit any growth. For example, if the S&P 500 gains 20 percent in one year but your EIA has a cap of 5 percent, your gain will be limited to 5 percent. Also, while the S&P 500’s growth rate is often measured with dividends included, many EIAs exclude dividend returns from the rate on which they base your payment.
If your money is invested in an EIA, it can be locked up and inaccessible to you for many years, with early withdrawal penalties topping 10 percent.
EIAs are not insured by the Federal Deposit Insurance Corporation (FDIC), either.
If the issuing company fails, your investment might, too. Meanwhile, when you buy an EIA, you forgo the now-favorable tax rate for long-term gains. Any gain in an annuity is taxed as ordinary income.
Know that you can lose money with equityindexed annuities. They seem to serve those who are selling them more than those who buy.
Look closely before you leap — and learn more about retirement strategies at aarp.org/retirement and fool.com/retirement.