Equity Indexed Annuities (EIA’s) versus Stocks
An Annuity is a contract entered by an individual or an investor with an insurance company. There are many components that make up an annuity. One of these components is the amount of the initial payment (or premium) an investor has to deposit. Both the insurer and the investor then agree to a term which can vary. It could be a short, medium or a long term investment and it can range from 1 year or even up to nearly 20 years with some contracts. The insurer then offers either a rate or crediting strategy depending on how long the investor promises to leave the money with the insurance company.
There are different types of annuities. Most fixed annuities have some degree of guarantee associated with them. The interest rate could be guaranteed for the entire term of the investment. The interest rates on guaranteed annuities are usually larger than a CD’s rate of return. Another type of annuity is the variable annuity. The funds invested are reinvested to mutual funds and because of this design; these types of annuities are more dependent on stock market movements. Hence, it has more potential to have larger gains, but also has the risk of losing value, just as a stock can lose value. The value will go up or down depending how the funds within the annuity perform. An Equity Indexed Annuity shares some of the traits of a fixed annuity, but has more potential for interest rate earnings. An equity indexed annuity has different crediting methods that follow a specific index. The most popular index that EIA’s follow is the S&P 500, but there are others as well. An EIA has a crediting method that has an element of participation in the index, or a cap. They are designed to follow the performance of a stock market index so that some of the gains can be credited, but none of the losses.
Stocks on the other hand, carry more investment risk. Rather than being a contract entered into with an Insurance company, stocks represent actual ownership of the company. Therefore any gains or losses represented are the actual gains or loss of the investor, without caps or limitations. While the owner of an annuity may be protected by the state in the event that an insurance company were to become insolvent, should a company become insolvent the owner of the stock loses their investment. They are dependent on many factors, one of them being market risk. A good financial planner can help you determine whether or not a stock or and EIA is the most appropriate investment.
Annuities are best suited for long term investors. Any withdrawal prior to age 59 ½ is subject to a 10% tax penalty as well as regular income tax. Annuities often also have a surrender schedule, meaning that withdrawals may be subject to a penalty by the insurance company if not left in for a predetermined amount of time. Any guarantees on principal invested is based upon the claims paying ability of the underlying insurance company.