An Equity Indexed Annuity (EIA) is a type of investment where your interest is linked to a stock index, such as the S & P 500, Russell 3000 or other index. The investment credits your account with a percentage of the gain of the market. This percentage is also called “participation rate”.
For example, let’s say your EIA is linked to the S & P 500 and has a participation rate of 70%. If the S & P 500 goes up by 10% your investment is credited with a 7%. return Some EIA’s even guarantee a minimum interest rate (3% is common) if the index falls flat or loses money.
How does an EIA compare to a mutual fund?
Mutual funds, potentially, have more upside because there is no participation rate. You are credited with 100% of whatever return is generated in a mutual fund. But you also earn 100% of the losses too. If your mutual funds earn 15% you are credited with 100% of that. If they lose 15% your investment is reduced 15%. With a mutual fund, there is no downside protection when the market tanks.
An EIA typically offers you downside protection. You and the insurance company share in the profits. In return, the insurance company guarantees that you will never lose money (in contracts that offer a minimum guaranteed rate of return). Some EIA’s simply guarantee a 0% rate of return in the worst case scenario. That still is better than a mutual fund that might see a double digit loss in down market years.
The Equity Indexed Annuity has become a very popular vehicle for saving money. One main reason is its ability to earn a higher rate of return than other investments (fixed annuities or CD’s, for example). The EIA protects your principal and credited interest while maintaining the ability to earn substantially higher rates of return than CD’s or fixed annuities. An owner of an EIA will earn money when the market rises but not lose money when the market falls.
The downsides of an EIA are few: non-participation in dividends and a lack of full participation in market gains. Like most annuities, the EIA has limits for pulling money out for a specified number of years. But for those who are saving for long term and do not need immediate access to their money, and are willing to give up a piece of market gains for a guarantee their investment will not lose principal in down years, the EIA makes great sense.