Disadvantages of Equity Indexed Annuities

Confusing Numbers

A quick pitch explains a product in a few sentences, essentially giving you the overview. The problem is that the equity index annuity has so many caps and limits on earnings potential that there is no quick way to explain it. For example, an index annuity may have a minimum guarantee of 2 percent and follows the S&P 500 so when it goes up, your money goes up. Assume the S&P 500 has a great year with a 20 percent increase, so you get 20 percent. Not exactly. Index annuities cap your upside potential not one, but two ways. Your participation rate says you can only earn 80 percent of the 20 percent, which is 16 percent. That's still great for a guarantee until you learn the cap rate is limited to 8 percent annually. Annual administrative fees are then taken from that amount.

Annuity companies retain the discretion of how to determine when the market is up. You can watch it and see the annual return, but depending on how the annuity contract defines "up," you may not get as much as you thought you would. If your annuity uses a point-to-point index method, it takes your contract date and determines the value at the anniversary date. This may be dramatically different than the annual return or the high-water mark -- the highest value of the index during the year.

Annuities are contracts with durations called surrender periods. Index annuities can be anywhere from three to 15 years in duration with penalties for early withdrawal being as high as 25 percent. Considering that index annuities are sold to senior citizens seeking to preserve capital but improve income amounts, the long terms and high penalties become counter productive to the potential value an index annuity offers.

Equity indexed annuities offer some of the highest commissions to financial advisers compared to other financial products. With commissions at times being twice as much as normal annuities, consumers need to consider whether the financial adviser is recommending this product because it really is the right product for them or doing it for the increased payout. The high commissions have damaged the reputation of equity indexed annuities in an annuity market already rampant with media and regulatory warnings over unsuitable annuity sales.