Equity-Indexed Annuities

Equity-indexed annuities are fixed annuities with earnings tied to the S&P 500 and a lifetime guarantee so you're not penalized if the market goes down.

Traditional fixed annuities are a safe way to invest money for retirement. But often, the drawback with lower risk is a lower rate of return. Indexed annuities may provide better growth for your money versus an annuity with a level interest rate. By linking the interest your policy earns to a major market index, you may accumulate more money over the long term. At the same time, indexed annuities feature a minimum interest rate. This rate helps provide growth even when the market performs poorly.

How it works

When you buy an indexed annuity policy, you make an initial premium payment. If you are purchasing a single premium annuity, this is the only payment you will ever make. But a flexible premium annuity allows you to make additional premium payments to your account.

The money in your annuity earns an interest rate that is benchmarked to a major market index—usually the Standard & Poor’s (S&P) 500TM Composite Stock Index. This means that your interest rate can change and is calculated based on the annual performance of your policy’s market index. The interest earned is usually a percentage of the index’s performance referred to as an index participation rate. The participation rate is subject to a cap, which sets a maximum participation rate. The interest is paid yearly on your policy’s anniversary date.

Because of this index participation rate, you are able to participate in a percentage of the growth of the market index. But unlike with a securities product that may lose value, you are provided with an interest floor. So even in years where the index loses value, you still earn a guaranteed minimum interest rate.

The interest your annuity earns is tax-deferred. Once you begin to withdraw money from your annuity, income tax is owed on your annuity’s earnings. If you are retired and no longer employed full-time, you are likely to qualify for a lower income tax bracket.

Using the money in your indexed annuity

At retirement, you may choose among several options of payout. For example, you may want to receive income payments for the rest of your life, for the rest of your and your spouse’s lives, or for a specific number of years, choose to withdraw the money as one lump sum, or you can make occasional or periodic withdrawals from the annuity.

In most cases, annuity policyholders can also access the cash value of their account prior to retirement. Many index annuities allow you to withdraw a percentage of your account’s value each year without paying a surrender charge. When you need to take out more than this specified percentage, you will likely be charged a fee based on the number of years you have owned the policy and the amount you are withdrawing.

Advantages and disadvantages of indexed annuities

With an indexed annuity, saving for retirement may be easier than you think.

Advantages of an indexed annuity include:

• Allows you to participate in market growth through an interest rate linked to a major market index.
• Guaranteed minimum interest rate that provides growth even when the market performs poorly.
• Tax-deferred growth helps your money grow more quickly.
• Guaranteed death benefits help ensure your beneficiary’s financial security.
• Limited withdrawal privileges without charge to give you access to your money.
• Several income payment options so you can receive income when and how you want it.

Some disadvantages of an indexed annuity include:

• Interest your account earns is only a percentage of index gains and is subject to a maximum cap.
• Potentially high fees for withdrawing money that exceed the annual limit.
• Withdrawals prior to age 59½ may be subject to a 10% penalty tax.